Are Fannie Mae and Freddie Mac Poised to Jump on Strong Housing Trends?

In this segment from Market Foolery, the team reaches into the mailbag to tackle a question from a German listener. Axel wants to know whether signs of strength in the U.S. housing market could make Fannie Mae (FNMA -8.97%) and Freddie Mac (FMCC -5.38%) attractive investment opportunities. Tune in to learn more.

Chris Hill: Email from Axel Bruckner in Germany: "I heard you speaking recently about good indicators for a strong U.S. housing market in the future, so I'm curious how you would evaluate Fannie Mae and Freddie Mac. The upside for these stocks seems tremendous compared to the risk." What do you think, Jason?

Jason Moser: I would actually probably beg to differ there. I guess, maybe, he's thinking upside compared to risk, and risk meaning that these are companies that are more or less underwritten by the U.S. government. So, yeah, from that perspective, the risk is, generally speaking, probably pretty low. But I think understanding what these companies do, they make their money from, essentially, fees and net interest margins, so they're more or less like a bank. But they're not stocks that trade on any underlying business fundamentals. I think they tend to trade more on who's in office, and what court ruling recently went in their favor or in someone else's favor.

So to me, they're not really businesses as much as they are necessary entities, and we're trying to figure out where they fit in our housing market going forward. Because clearly, something went wrong not too terribly long ago. I think when we look at housing in general, the housing opportunity for investors is absolutely a must in the portfolio. You look at that as one of the bigger picture plays that you need to have in your portfolio one way or another. I would not look at one of these two businesses as a way to do that. I think if you're concerned with one of these businesses, I don't know why you wouldn't just pick a big bank, because then at least you have a bank that's going to be based on profits, and you're going to see dividends, and stocks that trade a bit more on fundamentals. But I think the opportunity is there. If you look at home ownership rate here, going back to 2005, right about when it peaked, it's been on a pretty steady decline since then.

Taylor Muckerman: Slow, yeah.

Moser: Yeah, it's reverted all the way back to below where it was in 1995. So, I think there are plenty of opportunities. I think this notion that millennials are not buying houses is misguided. There is data to prove that they are. They're certainly being a bit more particular, a bit more considerate when buying houses. But ownership is one of those things where, yeah, at 20 years old, you're like, "No, I'm not going to buy a house, of course not, I'll tell you I'm not going to buy a house," but then life happens. When you hit 25 to 30 years old, things change. You don't mean for them to change, they just do.

Hill: And that's also one of those narratives that's now four or five years old. There are stories that I've seen online that speak to that, they're parroting that same line, and you read them and think, "I think you're being kind of lazy."

Moser: What do you mean, the line that millennials aren't buying homes?

Hill: Yeah, like "That was the case five years ago and the data proved it, therefore I'm going to just repeat that line." Maybe it's time for some updated data.

Moser: Right. If millennials aren't buying homes, you need to prepare for a home ownership rate more like 40%, and I'm just telling you, that's not going to happen.

Muckerman: Yeah. They're not getting the opportunity. It's not that they don't want to. A lot of new home builds are generally being priced mid-market to high-market now. They're not really getting entry level prices to buy their first house. So they probably want to, but it's a little bit more difficult for them to, because I think new builds are still pre-recession levels. It's on an uphill slope right now. We're still far, far behind in terms of opportunities to buy a brand new house for these folks. And some of the hotter cities where you're seeing millennials move, they're priced out of the market, and it's become a rental society in a lot of these cities, with banks, after the recession, buying up a lot of the inventory and renting it out, and not offering these used homes for sale. And if you're not building new homes, you're stuck in limbo there.

Moser: Yeah, and the economics dictate it. It's all about supply and demand, just like any other market. I was reading about this, I think it was in Minnesota, of all places, you're seeing homes that are going on markets that, they don't last but a couple of days on the market before they're gone. Speaking from recently selling a townhouse of ours in Fairfax here, which is a pretty good sort of entry level price for this area, and I mean, this is an area where housing is a bit more expensive, our house was gone in less than a weekend, because the price was attractive. So you're seeing, in areas where Millennials or first-time home buyers have that opportunity, they're definitely jumping in there. And where there is lower supply, those home builders are going to come in and start building more for those types of buyers. So you look at all of the different ways you can participate in that market, and it's anywhere from retail, like Home Depot, to something like Ellie Mae, which I've talked about a million times on our shows, taking a part of every loan that goes on out there, or something like a big bank where you can get that dividend in --

Muckerman: Timber companies, nice diversifier, softwood lumber.

Moser: Yeah, material suppliers. I look at something like Freddie Mac or Fannie Mae, and I think, well ...

Muckerman: There's better options out there.

Moser: Way, way better options.

Hill: I do, however, like how Axel is thinking about it, just in terms of the upside relative to the risk. Regardless of whatever stock you're looking at, that's a great exercise to go through.

Moser: No question.