Housing stocks have soared since they bottomed in October 2011 — the S&P Homebuilders Select Industry Index is up nearly 180 percent since that time, compared to 90 percent for the S&P 500 — so you could be forgiven for thinking that the home-related rally is over. Many fund managers, though, say otherwise. In fact, another leg of the rebound may be just beginning.
Take a look at the data and you'll see that the housing market is still trending upward. In February, housing starts increased by 5.2 percent over the month before, hitting its highest level in five months, while over the last year, housing starts have climbed about 31 percent. In January, U.S. existing home sales had one of its best months, topping 5.47 million sales, while foreclosure rates have now fallen below pre-recession levels.
There are other positive indicators, too. Sales prices are increasing and supply is tight, but at the same time, wages are growing — incomes expanded by 2.3 percent over the past year in March — and the economy is adding jobs, about 600,000 year-to-date. Housing-related stocks also continue to do well. Home Depot, for instance, is up 17 percent over the last 12 months, while the S&P 500 is down by 0.6 percent.
One of the biggest drivers, though, is new homebuyers. Historically, 40 percent of all home purchases have been by first-time buyers, but the group represents about 30 percent of home sales today, said Rich Heidemann, a U.S. housing analyst with Waddell & Reed. Many people are finally making enough money to leave their apartments or their parents' place and buy something for themselves, he said.
To Steve Brown, a real estate portfolio manager with American Century Investments, the market is now in the "fifth inning." While investors won't see the massive gains experienced earlier, he thinks that housing stocks will see steady, though still above average, returns. Investment experts have identified three areas of opportunities for investors: homebuilding stocks, home-improvement companies and real estate investment trusts.
Heidemann is bullish on homebuilders and thinks they still offer a lot of upside. March saw 1.2 million housing starts, which is lower than the 1.5 million starts that Heidemann thought there would be by now, which means there's still a good runway for growth in this subsector, he said.
At the moment, the homebuilders group is trading at about 1.3 times price-to-book, he said, which is below the 2 times price-to-book that it's traded at when people have gotten overly excited about the housing sector. He doesn't think the group should trade below 1 time, so to him prices are attractive today.
There's one part of the housing market in particular that's seeing strong demand: homes selling for $250,000 or less, said Heidemann. Those deals can be found in areas like Texas, Florida and Georgia. A company like D.R. Horton (DHI), the country's largest home construction company, has exposure to these fast-growing markets, he explained. "That's where the demand is right now," he said. "It's on the low end, where the growth is going to come from this year."
Investors would also be wise to look at stores like Home Depot, Lowe's (LOW) and other consumer-facing companies that help people with furnishings or renovations. Essentially, the more people who own homes, the more stuff they'll need to put into their abodes.
However, there is more to it than that, said Brian Nagel, an analyst with Oppenheimer & Co. After the recession, when home values were declining across the country, people didn't want to invest money back into their homes. Now, with home sales increasing — the S&P/Case-Shiller Home Price Index rose 5.4 percent year-over-year in January — people are feeling better about spending money on their dwellings.
"That's the biggest factor," he said about why Home Depot sales continue to improve. "One of the by-products of a recovering market is climbing home values. People feel better about putting money back into their home if they know it's going up in price."
Home Depot, and stores like it, won't see the gangbusters growth experienced when they were coming off the bottom. Home Depot increased by about 133 percent from mid-August 2011 to the end of 2013. It's up 64 percent since, but it will continue to rise at a more steady clip, said Nagel.
A big advantage now, though, is that these companies are much better run than they were before the recession, said Nagel. They'll see upper single-digit earnings growth going forward, but every dollar goes further today than it did a few years ago. He thinks Home Depot, which is trading at $134 a share, will hit $150 over the next 12 months.
The case for REITs
Another place for investors to look is the REIT market. Most housing-related REITs are in the rental space, which has been a major area of growth over the last five years. However, the dynamics of that market are starting to change, said Brown. Rent growth, while still rising, is beginning to stagnate, in part because demand is now growing at the same pace as supply.
Still, there are opportunities. The best apartment REITs will have exposure to the middle part of the country, such as Tampa Bay, Florida; Chicago; St. Louis, Missouri; or Phoenix, said Brown. These markets are doing better economically, there's more job growth, and there's less construction activity than in coastal markets.
Denver-based Apartment Investment and Management (AIV) is one company that Brown likes, because it's well diversified across the country but has a lot of exposure to the areas where rents are still expanding.
There are also a few REITs, such as Colony Starwood Homes (SFR), that own houses for rent. This company, in particular, is interesting because it's trading at a "sizable" discount to its net asset value, said Brown, yet housing rents are growing faster than apartment rents. These rentals are harder to come by and appeal more to families, he said, hence the faster growth. At the same time, the homes it owns are appreciating in value.
Clearly, there are opportunities in this still-expanding sector, but investors may want to act soon, said Brown. He thinks that housing will continue to do well for at least another 12 to 24 months. Expect more steady growth in the past — Heidemann thinks housing starts will increase by about 10 percent a year — but he, too, thinks investors can find good buys now.
"I'm bullish," he said. "We're below the normal cycle of housing starts, household formation is picking up, prices are rising — these are all things that get me excited about the space."
— By Bryan Borzkowski, special to CNBC.com