Investors looking to bet on a U.S. housing recovery might take a cue from the Sage of Omaha.
Legendary investor Warren Buffett, who owns housing-related businesses through conglomerate Berkshire Hathaway Inc., has been raising his own wager. He recently teamed up with Canada's Brookfield Asset Management Inc. to more than double the size of his U.S. real-estate brokerage business, and launch Berkshire Hathaway Home Services as a new franchise brand.
There are other signs of a rebound in building momentum, nearly six years after the housing bubble burst. The Standard & Poor's/Case Shiller Index indicates that home prices rose 2 per cent in August – the third straight increase. The inventory of homes in foreclosure is falling. And mortgage rates are expected to stay low in the wake of the U.S. Federal Reserve Board's decision to buy mortgage-related debt.
Housing stocks have already been bid up in anticipation of a recovery. The S&P 500 homebuilders index, which tracks the stocks of DR Horton Inc., Lennar Corp. and PulteGroup Inc., is up more than 100 per cent this year, and observers suggest that this house party isn't over.
"We are very, very bullish," said RBC Dominion Securities analyst Robert Wetenhall. "We still see upside going into next year. Publicly traded builders will continue to beat expectations, while also raising guidance … We think the housing recovery is in full swing, and is going to accelerate in 2013 to 2015."
Homebuilder stocks typically move in tandem, but Lennar is "our best idea for investors with a two-to-five-year horizon," suggested Mr. Wetenhall. "We also think that KB Home, which trades at a sizable discount to the peer group, will close the gap. And PulteGroup is a show-me story … We have seen two quarters of substantial improvement [in gross-margin performance], and we think that is likely to persist."
Within the building products sector, he sees Fortune Brands Home & Security Inc., which has the No. 1 market share in cabinets and owns the Master Lock brand, as the best way to play a recovery in home construction. He is also a fan of wallboard maker USG Corp. – a Berkshire Hathaway holding – and gravel producer Vulcan Materials Co.
Exchange-traded funds offer a more diversified way to make money from a housing turnaround. The iShares Dow Jones U.S. Home Construction ETF (ITB-NYSE) is a market-capitalization-weighted index with 65 per cent invested in homebuilders, and the rest in firms such as building material producers and home-improvement retailers. The SPDR S&P Homebuilders ETF (XHB-NYSE) is an equal-weighted index with only 28 per cent allocated to homebuilders, with the rest in other housing-related stocks.
Given the runup in housing stocks, "it is good idea to be prudent," but it is not reason enough to shun the industry, given that many of the equities are rebounding from "disaster or bankruptcy scenarios in the wake of the housing crisis," said John Gabriel, an ETF strategist with Morningstar Inc. While SPDR S&P Homebuilders ETF may seem more palatable to investors concerned about the surge in homebuilder shares, both ETFs have performed similarly over the past five years, he noted.
The U.S. Housing Recovery Fund (USH.UN), a closed-end offering that listed this week on the Toronto Stock Exchange, is another way to get exposure to the housing sector. The fund is equally invested in 30 companies ranging from homebuilders to houseware and appliance names such as Bed Bath & Beyond Inc. and Ethan Allen Interiors Inc. It differs from an ETF in that the manager will also write covered call options to generate income. The fund, which has a five-year life, has a targeted monthly distribution of 5 cents a unit – implying an annual yield of 6 per cent at its $10 initial public offering price.
"We believe there is more upside to these [housing-related] stocks" because of the rise in household formation, which had slowed since the financial crisis, and continued low mortgage rates, said Neil Murdoch, president of Connor, Clark & Lunn Capital Markets Inc., which manages the fund. "A lot of young people stayed at home rather than moving out, so our expectation is that, as the economy gets better, they will start moving into a house."
While rising unemployment and anemic economic growth could derail a housing recovery, the big risk looming now is the U.S. fiscal cliff of tax hikes and budget cuts, set to take effect next year unless U.S. Congress agrees on a new budget plan.
"We are expecting some kind of congressional compromise," RBC's Mr. Wetenhall said.