By: Phil Kernen
Housing was the industry most directly affected by the interest rate increases engineered by the Federal Reserve in 2022. Higher borrowing costs in an expensive housing market throttled activity and put many potential buyers back on the sidelines. For investors looking through the wreckage, the opportunities could be good.
Housing isn’t bottoming yet, despite the pullback in mortgage rates over the last few months. Month-over-month sales of new homes grew slightly in December and January, 2023. However, the only positive aspect revealed from building permits to housing starts to existing home sales is the reduced speed of the slowdown. The bottom will arrive eventually.
The lack of positive data, however, hides opportunity. Housing investment goes beyond homebuilders, one of more than 100-plus industries, whose 2022 return was only slightly worse than the S&P 500. Consider the companies whose business depends on broad housing ownership more than the number of housing transactions. Home Furnishings, Household Appliances, Home Improvement Retailers, and Building Products declined more and represented an opening to buy stocks whose prices fell too much.
Companies in these industries are only partially dependent upon housing transactions like new home sales or existing homes changing ownership. With interest rates rising, more homeowners are deciding to stay put and keep their relatively lower mortgage rates and choosing instead to improve, renovate, and refurnish existing homes. Merely maintaining existing housing stock provides an enormous market to drive earnings for well-managed suppliers and retailers.
At the same time, the U.S. has a large and growing housing deficit. The Federal Home Loan Mortgage Corporation, created in 1970 to expand the secondary market for mortgages in the U.S., estimated in 2018 that the U.S. housing shortage was 2.5 million units. In 2020, they estimated the deficit had widened to 3.8 million units. Homebuilders are doing what they can to address the shortfall within the limitations of limited labor availability, supply costs, and the affordability of final selling prices. Making headway on a large scale is a challenge considering that the underbuilding of entry-level homes accounts for much of the shortfall. The pressures for new housing stock to address the deficit are material and sticky. Narrowing the gap will take a long time. Any progress will support the earnings of companies selling goods and services to new and existing homeowners alike.
Exiting the pandemic and our renewed focus outside our homes, share prices for many suppliers to the housing market suffered, sometimes materially. The industries above were off anywhere from 20-25% to 35-40% or more. Not every company is a candidate, and some deserve their low valuation. However, many are well-run companies whose values declined with the housing outlook, but they retain solid earnings and income-generating capabilities that are now on sale.
Because of government policy and market demand, construction activity and housing stock growth are expected to grow alongside renovation spending for existing homes. When stock markets turn negative, opportunities arise to find undervalued stocks with upside potential. Interest rates may have housing looking down and out, but prospects are bright if you look in the right place.
Disclosure: This is for informational purposes only and any reference to a specific industry does not constitute a recommendation to buy or sell a company in that industry. The reader should not assume that an investment in the securities identified or described, was or will, be profitable. For a complete list of disclosures, please click https://mitchcap.com/disclosure/
