There are a few different ways to invest in housing without actually buying properties. You can invest in real estate investment trusts, or REITs, that focus on residential real estate. You can buy shares in a homebuilder. Or, you could invest in a business that's related to housing, such as a real estate website or a retailer that sells construction supplies to homebuilders.
However, there are a lot of housing stocks to choose from. Even if we narrow down the search to stocks that trade on major exchanges with market capitalizations greater than $250 million, there are 18 residential REITs, 20 homebuilders, and dozens of companies that are more indirect investments in housing.
Image source: Getty Images.
To help narrow down the search, here are five housing stocks that look extremely appealing as long-term investments.
Type of Business
Home Depot (NYSE: HD)
AvalonBay Communities (NYSE: AVB)
NVR (NYSE: NVR)
Zillow Group (NASDAQ: Z) (NASDAQ: ZG)
Real estate website
American Campus Communities (NYSE: ACC)
Data source: CNBC. Market capitalizations as of 7/11/19.
Home Depot: The biggest (and best) home-improvement retailer
Home Depot is not only the largest home-improvement retailer, but it's also the largest housing stock of any type, and by a big margin. The only U.S. retailers larger than Home Depot are Amazon.com and Wal-Mart. The company had nearly 2,300 stores in North America and generated $108.2 billion in revenue in 2018. This is a massive company, and is a major source of construction supplies like lumber, tools, and more for homebuilders.
Many investors are afraid to invest in any retail stocks right now, and with the high-profile bankruptcies and store closures involving some once-great retailers, who could blame them? However, Home Depot is different.
For one thing, Home Depot is largely immune to the e-commerce headwinds that have created a nightmare scenario for many retailers. Professional customers (like homebuilders) and everyday consumers generally need to physically look at construction and home-improvement products in person. In other words, if you need to buy 4x8 sheets of plywood, you generally aren't going to order them online.
Furthermore, Home Depot is doing quite a good job of building out its e-commerce platform and omnichannel capabilities itself. This is true even when compared with competitors -- for example, in the fourth quarter of 2018, Home Depot grew online sales by 24% year over year, more than double Lowe's 11% pace.
Despite its massive size, Home Depot continues to grow sales nicely, and at a time when many retailers have faced years of declining revenue. To sum it up, Home Depot's massive scale, superior omnichannel approach, and the in-person nature of its business should keep it an outperformer in the retail world for years to come.
AvalonBay Communities: High-value apartment communities and lots of room to grow
Real estate investment trusts are a special type of company. In order to qualify as a REIT, a company needs to invest at least three-fourths of its assets in real estate and related investment, must derive at least three-fourths of its revenue from these investments, and must pay out at least 90% of its taxable income as dividends to shareholders, among other requirements.
As you might expect, REITs typically have above-average dividend yields thanks to this last requirement. They also enjoy special tax treatment -- because they pay out virtually all of their taxable income to investors, REITs are not taxed at the corporate level. In contrast, most other companies in the U.S. are subject to corporate tax on their profits, which currently is a flat 21% rate.
Although it's roughly one-eighth the size of Home Depot, AvalonBay Communities is the largest real estate investment trust, or REIT, focused on residential properties. If you aren't familiar with its business, AvalonBay develops, acquires, owns, and operates apartment buildings in high-barrier markets in the U.S.
As of March 2019, AvalonBay owns 291 apartment communities, the majority of which are located in its six core markets of New England, New York Metro, Mid-Atlantic, the Pacific Northwest, Northern California, and Southern California. However, the company has recently started to expand into two largely untapped new markets -- Southeast Florida (think Miami, Fort Lauderdale, West Palm Beach, and surrounding areas) and the Denver, Colorado metropolitan area.
In a nutshell, the company invests in high-cost markets where homeownership is often prohibitively expensive for many buyers. And these are markets where there is limited supply of rental housing, and with strong job and wage growth and favorable demographic trends.
While it acquires properties as part of its growth strategy, AvalonBay's preferred method of growth is through development of new properties, which is perhaps my favorite thing about the company. Let's say that the average apartment building is selling at a 6% capitalization "cap" rate. This means that an apartment property with a market value of $10 million can be expected to produce net income of $600,000 per year. However, if you can build the same property for $8 million, your annual return will be a far more attractive 7.5%. Plus, you will have created $2 million in equity for your investors.
AvalonBay invests heavily in development, having spent a total $2.4 billion during 2017 and 2018 alone. The company estimates that development activity by itself has created $26 per share in net asset value in this manner since 2011, so it's no wonder it sees development as a priority.
The company's strategy seems to be paying off. From its 1993 IPO through early July 2019, AvalonBay generated 3,110% total returns for shareholders (as compared with 960% for the S&P 500) and has increased its dividend at a 5.2% annualized rate during that time. To put this into perspective, this means that a $10,000 investment in AvalonBay's IPO 26 years ago would be worth more than $310,000 today.
NVR: A homebuilder with a unique business model
When it comes to homebuilders, I tend to group the bigger players into two categories -- NVR and everyone else. While it essentially produces the same product as most other major homebuilders, NVR's operations are just that different that it belongs in a category of its own.
Unlike many other homebuilders, NVR tends to stay profitable even in bad markets thanks to its unique business model. And NVR can operate in a much less capital-intensive manner.
Here's the big difference: Most homebuilders buy a large chunk of land, build out roads and other infrastructure, divide the land into buildable homesites, build a model home or two, and start marketing the remaining homesites. Then, if all goes well, customers will start buying homes and the builder will start to realize some income.
NVR does things differently. The company uses something known as land-purchase agreements to acquire its buildable lots. In a nutshell, the company puts down a small deposit in exchange for the right to purchase a buildable lot. It doesn't actually buy the lot until it has a signed purchase agreement for a home to be built. This makes the building much less capital-intensive than it is for most homebuilders, and also puts the company in a strong position to make it through bad markets.
Think of it like this -- let's say that a homebuilder acquires enough land for a 100-home community for $5 million, spends another $3 million building roads, running utilities, and building a model and a few spec homes. Right as these houses are complete, a massive recession hits and the housing market grinds to a halt. This builder just spent $8 million and has nothing to show for it.
On the other hand, NVR might come along and put 10% down on the purchase price for an initial batch of 20 buildable lots in a neighborhood -- let's call it $100,000. If a massive downturn hits and NVR isn't successful at even selling a single home, it can simply choose to lose its $100,000 deposit and walk away entirely. Meanwhile the other homebuilder is likely to end up with a major loss on its $8 million investment. This is a simplified explanation, but it's the general idea behind NVR's winning business model.
Because of this financial flexibility, NVR actually increased its market share during the housing crash of 2008-2009, as other homebuilders were forced to unload buildable lots at fire-sale prices. With positive net cash (more cash than debt), NVR has the best balance sheet among the larger homebuilders, which only adds to the financially flexible nature of its business.
With a deficit in new housing production in recent years, mortgage rates falling, and job and wage growth strong, it could be a great time to add a homebuilder to your portfolio as millennials enter their peak homebuying years. And NVR could be a great homebuilder to take a closer look at.
Zillow: The real estate disruptor
Most people know Zillow as the place to check real estate listings online, but it is becoming so much more than that.
To be clear, Zillow's core business is thriving. The site gets more than 180 million unique monthly viewers, and it leverages those to generate advertising revenue, provides services for real estate professionals, and more. Recently, however, Zillow has embarked on two ambitious new business strategies -- buying and selling properties and mortgage origination.
In 2017, the company announced Zillow Offers, which involves Zillow making all-cash offers to homeowners to purchase their homes. Zillow buys the home, makes repairs and updates, and lists the home.
To be clear, the business of buying and flipping houses is likely to be much lower margin than Zillow's other business activities. However, at the rate of 5,000 homes per month Zillow expects to achieve within three to five years, and room to scale this even higher in the future, it could certainly become a major profit source, especially as time goes on and Zillow figures out how to optimize the efficiency of the process.
Early results are promising. In the first quarter of 2019, Zillow purchased 898 houses (just under 300 per month) and generated $128.5 million in revenue by selling 414. Zillow planned to increase the number of markets for Zillow Offers from 14 to 20 by the first quarter of 2020.
Now on to the mortgage business. In late 2018, Zillow bought Mortgage Lenders of America for $65 million. Then, in April 2019, the company announced that it was rebranding Mortgage Lenders of America as Zillow Home Loans, a self-contained mortgage business originating loans without any middlemen. The goal here is to continue Zillow's disruptive trends. The company made searching real estate listing far easier than it had ever been before, then it made selling homes for cash quick and easy (in certain markets so far), and next it aims to do the same for mortgages, which the company claims are often the hardest part of buying a home.
According to Erin Lantz, Zillow vice president and general manager of mortgages, "with Zillow Home Loans we are taking an incredible step forward to deliver an integrated payments platform to complete the financing for Zillow Offers that delivers a more seamless, on-demand real estate experience today's consumers expect." To be clear, Zillow Home Loans is not restricted to buyers who purchase homes through Zillow Offers, but it is specifically designed to streamline the process.
Zillow anticipates originating 3,000 mortgages per month within the next few years, and mortgages can be a highly profitable business. With over 180 million unique monthly visitors to its site, I wouldn't be surprised to see this part of the business scale much higher in the future and become a tremendously profitable part of Zillow.
Between its still-thriving core businesses, the accelerating rollout of its home-flipping business, and a young but high-potential mortgage business after that, who knows what part of the business Zillow will decide to take on next? With sky's-the-limit potential, Zillow could certainly have a bright future ahead.
American Campus Communities: Because living in the dorms is so old-fashioned
American Campus Communities is a residential real estate investment trust that operates in a unique niche -- the company is entirely focused on the student housing market, with a portfolio of both off- and on-campus student housing communities. In fact, the company is typically thought of as the pioneer of the student housing industry, as it was the first (in the 1990s) to begin building apartment communities that were specifically designed for students. Properties offer student living spaces with more privacy than on-campus housing gives, as well as amenities such as swimming pools, community game rooms, state-of-the-art fitness centers, and more.
As of early 2019, American Campus Communities operated 170 student housing communities in 69 markets, which are mainly large public universities. Just to name a few examples, Arizona State University is American Campus Communities' largest university market, with Florida State University and University of Texas at Austin among its top ranks.
Here's the key point to know from a competitive advantage standpoint. The average on-campus housing facility in American Campus Communities' markets is more than 50 years old. Living environments generally don't have much privacy, these buildings lack modern technology infrastructure, and don't have very many recreational amenities. This is American Campus Communities' main competition, and the really shocking part is that these outdated dorms are just as expensive, or even more, than a modern apartment at one of the company's properties. The average private bedroom in an American Campus Communities property rents for $767 per month. This is just $10 more than the average shared on-campus housing unit and nearly $200 per month less than the average private on-campus bedroom.
No matter what business you're talking about, selling a superior product for a lower price is always an advantage. This is like if you sold only Apple iPhones and the newest Samsung Galaxy devices at your store, and the store next door sold low-end flip phones for the same price.
For income-seeking investors, it's important to point out that as a REIT, the company pays an above-average dividend yield, which certainly fluctuates over time but has remained well above the S&P 500's yield throughout its history, as you can see in the chart below. And the payout has never been cut in the company's publicly traded history (since its IPO in 2004).
American Campus Communities growth through both developments and acquisitions. Although the company's portfolio of over 109,000 rentable bedrooms as of March 2019 sounds like a huge amount (and it is), it's important to realize that this covers about 0.6% of the American college student population. So, there's still tremendous room for growth. In fact, American Campus Communities is known to aggressively build its market share in target markets -- as an example, more than 15% of the entire student body of Arizona State University lives in American Campus Communities' properties. Now, I'm not saying that the company will ever get 15% of the entire U.S. student population, but I don't think multiplying its current market share several times over in the next decade or two would be a big stretch.
Five great businesses
To be clear, I'm not saying that these are the only five housing stocks worth considering. They just happen to have unique business models with major competitive advantages, and I happen to think they all have superior long-term return potential.
The right pick for you depends on your particular investment goals and risk tolerance. For example, if income is a priority for you, you might want to consider one of the two REITs (although Home Depot has a pretty nice dividend itself). On the other hand, if you're a risk-tolerant growth investor, Zillow could be the smarter choice for you.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Matthew Frankel, CFP has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, American Campus Communities, Apple, NVR, Zillow Group (A shares), and Zillow Group (C shares). The Motley Fool has the following options: short August 2019 $195 calls on Home Depot, long January 2021 $120 calls on Home Depot, short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2020 $150 calls on Apple. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.