There are several reasons to be bullish on real estate right now.
For starters, Fannie Mae and Freddie Mac's looser and more clearly defined lending standards could open up the housing market to millions of buyers who previously couldn't qualify for a home -- particularly first-timers.
Further, mortgage rates remain at historically low levels, but we may see a rush to take advantage of those low rates, given that the Federal Reserve is widely expected to start raising interest rates in 2015. Finally, with rent rising faster than home prices in many areas, buying is starting to look like a more attractive option. So 2015 could be a pretty good year for the entire sector, and Freddie Mac economists have actually predicted a 20% year-over-year rise in new-home construction.
But which housing-related stocks should investors be ready to pounce on in 2015?
As far as individual homebuilders go, my personal favorite for 2015 is Lennar (NYSE:LEN), which has an extensive backlog of business that increased by 22% during the past year alone. The company has some unique and innovative products, such as "NextGen" homes intended to capitalize on the trend toward multigenerational households in the U.S. The company is also starting to venture into the apartment market through Lennar Multifamily Communities, which is already showing signs of promise and could become a nice driver of growth for the next few years.
Although Lennar stock gained more than 20% over the past year, I still think it's relatively cheap. Shares trade for 18.3 times trailing 12-month earnings, which is actually less than the sector average of 21.3, and the consensus calls for earnings growth of 40% by the end of 2016. Its price/sales, price/book, and PEG ratios are all less than the average as well.
Will the retailers maintain their momentum?
Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) benefit not only from rising new-home sales, but also from the improving U.S. economy, which has left consumers with more disposable income to complete projects and renovations in their own homes. The companies have already been seeing the benefits of this in their stores.
Further, both companies are doing an excellent job of running more efficiently and evolving their businesses. For example, Home Depot has done a fantastic job of integrating its online business with its physical stores, and 40% of the orders from the company's website are now picked up in-store.
Lowe's (my personal preference out of the two retail giants) is in the process of a fairly aggressive expansion in the U.S. and abroad. The company plans to open stores this year in underserved domestic markets, particularly urban areas. In fact, two new stores are expected to open in Manhattan during the year. Additionally, the company plans to further its expansion into Canada and Australia in the coming years. Thanks to these and other ventures, Lowe's expects to see its return on invested capital to grow from about 14% to 19% by 2017.
Lowe's has tremendous growth potential and still trades for a fair price, and it also has great management. A TTM P/E ratio of nearly 27 may sound a little high at first, especially for such a large and established company, but when you consider that earnings are expected to nearly double from 2014 to 2017 (projected 21.6% average annual growth rate), it seems a lot more reasonable.
Another testament to Lowes' strength and excellent management is the fact that the company has increased its dividend more than tenfold over the past decade and increased the payout every single year -- even during the financial crisis.
Lowe's has more room to grow than Home Depot and has an excellent strategy to make that happen, all while increasing the efficiency of its operations.
What could go wrong?
Of course, nothing is certain in investing, and this is certainly true of the housing market.
For example, mortgage rates could shoot up too quickly this year and scare buyers away. Or home prices could climb significantly in 2015, causing buyers to think homeownership is too expensive. Both of these scenarios are entirely possible.
Despite the risks, the signs still point to a solid year in the housing markets, and homebuilders and retailers should produce strong results.