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The housing market in the U.S. is showing some signs of recovery and if the trend continues, investors will be looking for opportunities.
"The housing market is showing some evidence of stabilization and even improvement in the U.S.," said Dan Kelley, the portfolio manager of the Fidelity Trend fund (FTRNX). "And with a reduction in inventory and an appreciation of rental rates across many markets, investors are taking another look and recognizing the value proposition the sector can provide."
Unfortunately, finding those investment opportunities might not be so easy at the moment.
According to Jason Pride, director of investment strategy at Glenmede, many of the investments that will benefit from a recovery in the housing market will be found in private markets, not in the easier-to-access public markets.
In an interview, Pride said public market real estate investment trusts, or REITs, which tend to focus on commercial real estate, are not the place to invest right now. Nor are REITs that specialize in residential rental properties. Most of those, he said, are now trading at premium valuations "as investors have flocked to the space in their hunt for yield." And the same goes for homebuilders, such as Hovnanian Enterprises (HOV), many of which have surged in value from the lows of last year.
Consider home-improvement retailers
Instead, the "one avenue that continues to make the most sense in the public markets has been the home-improvement retailers where valuations are reasonable and sales tend to go hand-in-hand with home sales," Pride wrote in his monthly report.
Home Depot (HD) is one of the retailers which is poised to benefit from improvement in the housing market.
"We still have a fundamentally positive view of the home-improvement retail market and believe it is still fairly early in the cyclical recovery," Peter Wahlstrom, an analyst at Morningstar, wrote in a recent report. "We plan to increase our fair value estimate to reflect the time value of money, [Home Depot's] overall outperformance in 2011, and management's encouraging 2012 outlook, which calls for low-single-digit comp growth and 50 basis points of margin expansion." Morningstar's fair value estimate for Home Depot, which trading at a 52-week high, is currently $49 a share.
Lowe's Cos. (LOW), which is trading at a four-year high, is the other big home improvement retailer to consider. Nomura Securities, for instance, this week upgraded its rating of Lowe's to a "buy" from a "hold". According to published reports, Aram Rubinson, an analyst for Nomura, said shares of Lowe's "have moved higher, but ample upside potential remains if our forecasts are correct... But by following HD's playbook we think it can find successes. Those in turn, can breed even more success. Risk remains, but momentum is more likely to turn positive than negative."
Don't forget home builders and banks
To be fair, there are some are some who are bullish on home builders. For instance, Tom Villalta, president and chief investment officer of Jones Villalta Asset Management, reports holding two home-builder-related stocks in the Jones Villalta Opportunity Fund (JVOFX) at the current time: Home Depot and Toll Brothers (TOL) .
"Toll Brothers has been agile and deliberate in their efforts to pick up distressed properties," said Villalta. "Their Gibraltar Capital and Asset Management subsidiary was established to purchase wholly or with partners distressed properties. I think they are really establishing themselves to benefit disproportionately from a rebound in housing."
Still, Villalta said, "Home Depot is, in my view, a safer route to participate in a housing recovery, or limit one's downside if the recovery takes longer. There is a link, but the company does not live and die by home sales, so, in our view, there is less risk."
Villalta also said bank stocks such as Bank of America (BAC) and Wells Fargo (WFC) are also avenues to get housing exposure. "Given both companies mortgage operations, servicing portfolios and loan portfolios, they have direct links to the housing market," he said. "Indeed, I would argue that the banking industry's problems are mostly related to the deflationary environment (driven by housing), and depreciation of underlying collateral (again, mostly housing). Both Bank of America and Wells Fargo suffered as a result of a falling housing market, and both will prosper with a resurgent housing market."
Distressed properties and non-agency mortgages
Pride also said investors should consider "distressed properties and non-agency mortgages where valuation opportunities" exist. But these are more private rather than public opportunities, he said. Investors would likely need to work with private equity groups that are buying and packaging distressed properties or they might consider investing directly in distressed real estate.
And indeed that is happening, according to Fidelity's Kelley, who also serves as the co-manager of the Fidelity Select Construction and Housing fund (FSHOX) . "One trend that is quietly occurring in the U.S. is the increasing number of entrepreneurs that are leveraging low-cost foreclosure opportunities to purchase single family homes for attractive rental yield opportunities," Kelley said.
Now truth be told, there are a few ways to invest in non-agency mortgages that are publicly traded. Those include the DoubleLine Total Return Bond fund (DBLTX), which had invested 30.6% of its assets in non-agency mortgages at the end of February; the PIMCO Mortgage-Backed Securities fund (PTRIX), which had some 5% of its assets in non-agency mortgages as of the end of 2011; and the TCW Total Return Bond fund (TGLMX), which had 38.9% of its assets in non-agency mortgages at the end of 2011.
And for those looking for a pure, though perhaps somewhat riskier, public play on non-agency mortgages might consider the Nuveen Mortgage Opportunity Term fund (JLS), a closed-end fund made up mostly of non-agency mortgages.
Pride, for the record, had one note of caution for those looking to invest in distressed property and non-agency mortgages. "The benefits of an improving residential real estate market will likely be slow to develop but should materialize in time," he said.
A question of when, not if
To be sure, there are those who might debate whether the housing market in the U.S. is rebounding or will rebound.
But Villalta is not among them. "Housing related stocks -- be they builders, retailers, mortgage providers or materials -- are opportunistic," Villalta said. "It is, in our view, not a matter of if housing rebounds; it's a matter of when. The longer that the housing market stays depressed, the greater the bounce back when it experiences a resurgence."
Villalta likens it to the crude oil market in the late-1990s. "If you recall, rig utilization was extraordinarily low, when oil was trading in single digits or the low teens," Villalta said. "This lack of exploration and production set the stage for a very significant bull market for crude oil."
Yes, there are obviously some differences, and housing and crude oil are not similar in many regards. "However, there is some commonality: when capital ceases to flow to an asset class or investment area, be it oil or housing stocks, the dearth of capital results in an undersupply of the product."
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