The U.S. housing market is back.
Recent economic data looks great. Household sentiment is strong. The market looks as strong as it's been in years.
For investors, a new housing bull market can translate into handsome profits. The key is to choose the right stocks to ride the wave.
The numbers tell the story
New homes sales through April of this year are ahead of last year by 22.4%. Pending home sales are crushing 2014's levels by 14%. Home prices are firming once again after a slower 2014.
At the same time, mortgage applications for purchases are also markedly up year over year, moving 13.1% higher. This is significant because mortgage activity has been largely dominated by refinancing applications since the financial crisis. Purchase applications indicate a return to healthy levels of buying and selling, instead of the opportunistic refinancing driven by low interest rates.
The Federal Reserve Bank of New York's 2015 SCE Housing Survey found that individuals are increasingly optimistic about housing as well, qualitatively supporting the empirical economic data. The survey found that 60% of households considered buying a home in their area a good investment versus just 10% who would consider it a bad investment. Households were optimistic that home values would continue rising, and renters reported that they would prefer to own if they had the financial resources to do so.
Which stocks will benefit
One of the few limiting factors to even stronger housing growth is a low level of completed homes available for sale. Inventories, in fact, are low for both existing homes and new construction.
The solution to that problem is to get more houses built and on the market. That's the business of home builders, a sector of the economy that stands to have the most direct gains from a housing boom. National builders like KB Homes, DR Horton, and Pulte Group have the experience, scale, and financial strength to grow the housing supply to meet demand and profit handsomely in the process.
Someone has to pay for all the houses being sold, and more often than not that means taking out a mortgage. Last year, the largest mortgage lenders in the U.S. were Wells Fargo, JPMorgan Chase, and Bank of America. Mortgage lenders also have an added benefit the home builders don't -- their profits will rise with an interest rate hike.
Banks earn their revenue from the interest they charge, so higher rates will translate directly to higher income from the loans on the books. This should give you a decent hedge on your home builder stocks in case sales decline in response to a Fed rate hike (more on rate hikes a little later).
While not directly exposed to the buying and selling of homes, building supply and home improvement companies like Lowe's and Home Depot will also benefit from the rising housing tide.
Many of the materials that go into home building are sourced from these companies, among others. At the same time, improving home prices will encourage homeowners to take on projects to renovate or remodel their existing homes. These big box home improvement retailers are the go-to source for homeowners when tackling these kinds of projects.
Possible headwinds to derail the housing train
Nothing is ever certain, and that's particularly true in the real estate market.
Of primary concern is the impact that a potential rate hike would have on the demand side. Will home buyers leave the market due to the higher expenses of an interest rate increase, or is the market sufficiently healthy to continue improving even with those added costs?
Historically, rate hikes have spurred a variety of reactions in the housing market, sometimes good, sometimes bad. The last time the Fed raised rates, in 2004, the housing market continued its rapid growth -- though this boom was largely fueled by the explosion of subprime mortgages.
The Fed has made it clear that when it does raise rates, it intends to do so slowly. Assuming the Fed follows through on that promise, I anticipate the housing market continuing its current trend. Slowly rising interest rates should not produce a headwind sufficient to counter the improvements in the labor market, in home prices, and in the banking sector.
To me, this means that now is a great time to consider investing in stocks that stand to benefit from a booming U.S. housing market. The home builders, mortgage lenders, and big box home improvement retailers are an easy and straightforward way to get market exposure without having to directly buy real estate yourself.