1 Great Way to Play the Housing Rebound

It seems the final wave of negativists have come around and accepted that housing is no longer in the dumpster. The writing has been on the wall for some time -- decades low new housing starts, upticks in prices, Warren Buffett constantly telling us housing is rebounding. As the last anti-housing stalwarts held out strong, housing stocks enjoyed a nice rally. Now, after a recent downward correction, many are wondering if the housing picks are worth buying the dip. To put it succinctly -- it's worth it.

Undeniably bullish signs
Let's take the recent pullback in housing stocks for what it's worth -- analysts pulling stocks down because they think the market "overreacted." Keep in mind, housing stocks have rallied, but they aren't nearly what they were before the bubble burst, circa 2005. Just take a look at homebuilder KB Homes (NYSE: KBH  ) . At the time, it was overvalued and riding an unsustainable wave -- trading at over $80 per share in mid 2005. Currently the stock trades at a little under $14. I don't expect, under any circumstances, for the company to return to those valuations, but you can see that this market "overreaction" needs to be put in perspective.

In a cyclical industry such as housing, trends follow very predictable patterns. The stocks peak at drastic P/Es that are more attuned to technology than housing or manufacturing. CNBC analysts talk about them incessantly, and your mechanic is giving you his top picks -- this is what happens every time. And this is exactly what isn't happening with housing stocks right now. Homebuilder stocks are certainly more richly valued than they were a year ago, but that was a time when new housing starts were at a 40-year low and demand was quickly passing supply. Housing starts are still well off historical norms, and the long-term trends for housing show a big need for new homes coming up -- giving plenty of room for stocks to rally on continuously improving conditions.

If you are still on the fence about the housing rebound, look no further than to the ridiculously low mortgage rates that will remain there for at least the next couple of years, the double-digit growth of applications for permits, and the decreasing appeal of renting given high rates and limited availability.

Now that I've got your attention, let's talk about one of the safer picks with solid capital appreciation potential.

A safe pick with high appreciation potential
It's not often a company announces quadruples profits and the stock drops, but that's exactly what happened last week with Lennar (NYSE: LEN  ) . The company reported third-quarter profits of $87 million versus $21 million the year before. This was due in part to a near $13 million tax benefit, but even with that taken out, the gains are still substantial and noteworthy.

Lennar has been the most stable of the homebuilder stocks over the last few years -- remaining profitable every year for the last three while competitors struggled. Along with KB Homes and other competitors, Lennar is enjoying increasing home prices, pent-up demand, and great interest rates. If you think it was a one-time thing, as some analysts have mentioned, the backlog jumped nearly 80% from last year and gives Lennar a great book of business looking forward. Even though the builders are back to work, housing supply is down in August to 4.5 months from 6.6 the year before. People are buying again, whether the bears want to admit it or not.

From its September 21st peak of $37.51, the stock has pulled back to $34.64 in just a few days for no reason other than "market sentiment." The term "market sentiment," in my opinion, should be changed to "total nonsense."

One more trend...
I try not to bludgeon you with numbers and facts, similar to certain presidential campaigns, but in this case, it's just another nail in the opposite of a coffin for housing. With the Fed's recent QE3 announcement, housing will only continue to benefit. As the government assures banks that it will buy bundled mortgages -- effectively shifting risk away from banks -- the banks will see little to no reason not to lend. Just watch as more and more home loan applications come pouring in, get approved, and translate to new homes across the nation.

If the home loan business is where you want to play your cards, which is certainly not a bad idea and can be less risky than the homebuilder/one-act pony stocks, check out Wells Fargo (NYSE: WFC  ) . As you likely know by now, Wells Fargo is a favorite pick here at the Fool and holds on to the largest portfolio of single-family home mortgages after the government. It won't see as big of an impact from the housing rebound compared to Lennar, but it is a great option for risk-averse investors.

If you'd like to learn some more about Wells Fargo, check out this special free report from our analysts. It lays out why you should look at Wells Fargo and other stocks big investors are buying.

Fool contributor Michael Lewis owns none of the stocks mentioned above. You can follow him on Twitter @MikeyLewy. The Motley Fool owns shares of Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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