A house is the most expensive thing most of us will ever buy, and that's reflected in housing's outsized influence on the U.S. economy. Housing contributes an estimated 15% to the U.S. gross domestic product, or about $3 trillion in annual spending.

Apartment buildings with trees and flowers along a city sidewalk.
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Housing-related spending takes many different forms from paying rent to buying a home to paying for upkeep and renovations. As a result, there are many different types of housing stocks to consider adding to your portfolio. Many are cyclical, and some are ideal for income-focused investors. For example, real estate investment trusts, or REITS, are particularly incentivized by tax laws to pay high dividends.

The bull case for the housing market

Why would you want to add housing-related stocks to your investment portfolio? Consider three long-term trends that should enable the industry to continue to grow for years to come:

  1. Low mortgage rates: Mortgage interest rates have risen from record lows, but they are still low by historical standards. Low rates encourage prospective homebuyers to enter the housing market and allow them to pay higher prices for their homes.
  2. Rising home ownership demand: Some millennials have entered adulthood unwilling or unable to become homeowners. As this generation ages, however, family creation will be on the rise, along with the demand for home ownership. Any federal government support to reduce the burden of student loans should increase housing demand by making it easier for younger buyers to afford their own homes.
  3. Rising time spent at home: The COVID-19 pandemic dramatically increased the time most of us spend at home, and many employees are likely to continue working at least partially from home as the pandemic subsides. With more time spent at home, the post-pandemic demand for home ownership is likely to increase.

Will inflation sink housing?

As noted above, conventional wisdom states that when interest rates rise, home prices suffer. Given all the talk of inflation, it's no surprise that homebuilder stocks have been under pressure of late.

Inflation could briefly take the wind out of housing, but there is still plenty of long-term upside. On a historical basis, the nation has a massive undersupply of housing stock. It’s going to take years of building just to match millennial new household formation and demand.

The best homebuilding and housing stocks

This is a broad category, and there are many competitors in each subsector. Here are a few standout companies in the housing sector whose stocks would make fine additions to an investment portfolio:

  1. NVR (NVR -0.22%) is a U.S. builder of premium homes, with a mix of new-entry, move-up, and luxury homes. Over the years, NVR has proven itself to be a disciplined risk manager, resisting the urge in good times to take on massive amounts of debt to buy property only to end up saddled with too much debt during industry downturns. NVR is also in the mortgage business, with fees from originations accounting for as much as 20% of the company's net income.
  2. LGI Homes (LGIH -0.05%) is focused on building entry-level homes, and the company has been one of the fastest-growing in the industry because of its ability to capitalize on millennials' burgeoning demand for home ownership. The company is laser-focused on costs, doing its best to ensure the monthly cost of owning one of its homes is within range of the region's prevailing rental prices. LGI's scale is sufficiently large to enable the company to compete on price in traditionally the most price-sensitive segment of the housing market. LGI Homes is well-positioned to continue growing rapidly.
  3. CareTrust (NASDAQ:CTRE) is one of many REITs that specialize in a particular segment of the real estate market. Some REITs are focused on apartments, while others invest in shopping centers or medical facilities. CareTrust is a healthcare REIT invested in senior housing and care facilities, and its current portfolio has about 200 facilities. The company is an attractive investment in part because of demographic trends. During the next 25 years, the baby boom generation will cause the nation's elderly population to balloon, creating significantly increased demand for senior living facilities.
  4. Home Depot (HD 0.74%) is the housing stock to own if you want portfolio exposure to consumer spending habits after home purchases are complete. The company enjoyed strong sales during the pandemic as people confined to their homes made more improvements around the house, and current high home prices will likely cause more people to remain in their current houses and renovate instead of moving. The trend, which is good for contractors, also clearly benefits Home Depot. The company has also brought the industrial distributor and one-time affiliate HD Supply back in-house, which gives Home Depot even more exposure to homebuilders and construction customers.
  5. Redfin (RDFN -2.07%) is attempting to disrupt the traditional home-buying process by charging lower sales commissions and using technology to make the process easier and more cost-effective. Redfin has several direct competitors, but the company distinguishes itself by offering both a broad range of home purchase and rental options and providing ancillary services such as mortgage origination. The national real estate market is highly fragmented, with the top 10 brokerages combined accounting for less than 50%. Newcomers such as Redfin are poised to grow rapidly without having to steal significant market share from the industry's incumbents.

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Top housing sector ETFs

Investors interested in the housing sector but not comfortable with choosing individual stocks can consider any of a large number of housing-related exchange-traded funds, or ETFs. The top housing ETF is the SPDR S&P Homebuilders ETF (XHB -0.54%), but be aware that the fund takes a broad view of homebuilding. Its largest holding is Johnson Controls International (JCI -0.17%), a maker of HVAC systems, and its second-largest investment is the stock of home furnishings retailer Williams-Sonoma (WSM -0.12%).

Comparatively specialized funds include the Long-Term Care ETF (NYSEMKT:OLD), which is focused on senior living, and the iShares Residential Multisector Real Estate ETF (REZ 0.42%), which owns stocks from a range of U.S. residential, healthcare, and self-storage real estate companies. There are also REITs specializing in retail, providing exposure to commercial real estate without having to pick a retailing winner.

Are housing stocks right for you?

Homebuilders don’t have the mega-growth potential of tech stocks, but given the urgent need for housing in the U.S., the industry is set up well to deliver for investors over the long term. Many of these companies also have predictable cash flows and return money to investors, making them solid income stocks.

Portfolios, like homes, need strong foundations. Housing stocks can provide the bedrock every investor needs.

Lou Whiteman has positions in Home Depot and Redfin. The Motley Fool has positions in and recommends Home Depot, LGI Homes, NVR, Redfin, and Williams-Sonoma. The Motley Fool recommends the following options: short November 2023 $12 calls on Redfin. The Motley Fool has a disclosure policy.