We are truly in uncharted waters. We’re seeing economic numbers the likes of which last happened in the 1930’s. The unemployment rate seems to be heading to 20% or higher, and U.S. GDP growth could hit some staggering figure like -20% or -25% in coming quarters. The shock is going to have a huge impact on the properties, and in particular, real estate stocks. Houses, offices, shopping malls and more — investors are suddenly questioning what everything is worth.
To understand the impact on the real estate market in general, we reached out to James P. Gaines, chief economist, Real Estate Center at Texas A&M University. He told InvestorPlace that:
“First, nobody knows at this point exactly how the pandemic is going to affect the real estate markets, but there is little doubt that it will have significant impacts. These impacts will first be the immediate short-run effects of much slower to near stoppage of new transactions — residential and nonresidential — while the economy is shut down and people are sequestered.”
So which real estate stocks in particular might be hit significantly by the novel coronavirus’ longer-term impact? Here are seven that stand out:
- Lennar (NYSE:LEN)
- Invitation Homes (NYSE:INVH)
- Simon Property Group (NYSE:SPG)
- First American Financial (NYSE:FAF)
- Zillow Group (NASDAQ:Z) (NASDAQ:ZG)
- Realogy (NYSE:RLGY)
- Home Depot (NYSE:HD)
Let’s take a deeper look into why each of these companies face big challenges from the resulting economic slowdown.
Real Estate Stocks to Watch: Lennar (LEN)
How will a near stoppage of real estate transactions end up affecting the market? The first area of concern is the housing market.
Housing was the catalyst for the 2008 financial crisis, and investors are wondering if a similar fiasco could happen this time around as well. While the housing market and banking system seem healthier now than they were then, questions remain. Mr. Gaines told us that he expects to see:
“Home sales fall tremendously once we work thru the backlog of signed contracts awaiting closing. This may take a month or so and the market is working on doing remote, online closings without having to actually attend a closing in person. Adding to the problem, of course, are the problems of appraisal and inspections that historically require a physical inspection. A very positive policy move was the prohibition on foreclosures and evictions for failing to make mortgage or rent payments. It remains to be seen how we will work through the financing chain from household payments to securitized mortgage bond defaults.”
Homebuilders like Lennar are obviously in the line of fire if these delays with contracts, inspections and closings drag on. Homebuilders tend to have a fair chunk of leverage. And their business relies on selling high-ticket items. As a result, an economic slowdown can wreck havoc on their cash flow if transactions dry up.
Lennar looks cheap though, trading at just 9x earnings. And home purchases had been booming right up until the quarantines started. The Federal Reserve’s massive rate cutting campaign has generated dirt-cheap mortgage rates, and has given folks more buying power. At this point, it’s not clear if consumers will feel comfortable buying given the economic stress. If they do, however, LEN stock could come roaring back.
Invitation Homes (INVH)
It isn’t just homebuilders that are nervous about the economic slowdown. There are publicly traded real estate investment trusts that solely focus on owning and renting out homes, and traders have sold those as well.
To give one example of a company in this space, look at Invitation Homes. It has more than 80,000 units around the country, with most of those being single-family houses. It primarily owns houses in strong economies with growing demographics. Its biggest markets include California, Florida and the fast-growing Atlanta metro market, among others.
Invitation completed its initial public offering in 2017. It’s still a relatively new company, and as such, it has been in aggressive growth mode. Until the market crash, INVH stock had traded sharply higher. Now, however, it’s back near its IPO price. While the dividend yield is a modest 2.5% for the time being, the REIT is priced to give a strong capital gain if and when the housing market picks back up again.
Simon Property Group (SPG)
Remember, housing is far from the only part of the real estate market that will face a massive impact from the coronavirus’ economic shock. Mr. Gaines explained the potential impact on commercial real estate:
“Forbearance is the operative word in the commercial sectors. Landlords will have to be patient with tenants’ ability to pay their rent. But really, they won’t have much choice as there won’t be any other tenants available to replace them.”
Simon Property Group is the nation’s largest mall REIT, and one of the highest-quality ones as well. The Simon family wisely spun-off its weaker malls into Washington Prime Group (NYSE:WPG) years ago. Washington Prime has lost nearly all its value; however, Simon held onto the best malls and until March 2020, it appeared to be in decent shape. Despite the retail apocalypse, Simon had enjoyed rising rents and sales at its top-tier properties.
But all that is in danger now. Simon’s stock has plummeted from $150 to as little as $40 during this bear market. While Simon has a fantastic balance sheet, investors are rightly concerned that the virus will cripple the company’s cash flows going forward. That’s particularly true as even high-end tenants with seemingly robust finances like Tesla (NASDAQ:TSLA) and The Cheesecake Factory (NASDAQ:CAKE) have decided to withhold part or all of their rent payments going forward. With rent in doubt, it’s not certain how Simon will react. One thing’s for sure: Dividend investors shouldn’t rely on Simon’s 13% yield for sleep-well-at-night income right now.
First American Financial (FAF)
Turning back to the housing market, there’s a lot more in play than just housing REITs and homebuilders. You have a bunch of other companies that are tied to the housing ecosystem. For example, take First American Financial, which is one of the nation’s largest title insurers. Title insurance is a service that banks require in order to provide a mortgage. The title insurer is response for guaranteeing that a property’s deed is in good standing. In the event of a problem with the mortgage, the title insurer may end up liable for damages if legal issues arise.
What do title insurers get in return for providing this necessary, if mundane, service? Fat fees, generally. Title insurers tend to earn a premium in proportion to the dollar amount of a real estate transaction. Thus, they have double leverage to the housing market. A booming market causes more transactions, and also increases the dollar amount per transaction, resulting in bigger fees. Needless to say, the downside is painful as both those levers run in reverse.
That said, the major title insurers did fairly well even in 2009, and this crisis shouldn’t be as bad for the industry as that one. For one, there was no major housing bubble this time around. There also doesn’t appear to have been much fraudulent mortgage underwriting in recent years, unlike 2008, which should reduce realized insurance losses for companies like First American.
While FAF stock dropped as much as 50% in the crash, shares should rebound quickly. Shares trade for just 8x normal-year earnings at this point and yield 4%. Demand for the product isn’t going anywhere — remember, title insurance is mandatory for new mortgages. Also, the Fed’s interest rate cuts should drive more refinancing; a refinanced mortgage produces a fresh title fee for First American as well.
Zillow (Z) (ZG)
Zillow is another fascinating housing stock to watch during this crisis. You probably know the company for its popular real estate website. On Zillow, you can track housing prices, get estimates for properties, see what’s on the market and much more.
However, more recently, Zillow made a huge switch to its business model. In addition to its traditional housing information portal, the company decided to get into the house-flipping game on its own. In theory, the company would have advantages in buying and selling houses thanks to its wealth of market information. It seemed like a dream job for big data analytics.
Alas, it hasn’t panned out — at all — so far. For full-year 2019, the company’s traditional businesses made a net profit of $7 million. Not great, but it was in the green at least. The home-flipping segment, however, lost more than $300 million, causing Zillow overall to take a big loss. The company projected better days ahead for 2020, but analysts were skeptical toward ZG stock as 2019 was a good year for the housing market, but Zillow still lost tons of money.
For now, Zillow is suspending much of its real estate buying and selling program to conserve capital. It’s also slashing other expenses to try to ride out the economic slowdown. However, investors aren’t convinced. ZG stock lost as much as 70% of its value recently before bouncing moderately. If the housing market takes a leg lower, Zillow could face real trouble.
Realogy Holdings (RLGY)
For another angle on the real estate market, take a look at Realogy Holdings. This company is one of the biggest real estate services companies in the U.S. It has a unique approach, as it has acquired a bunch of leading brands spanning things such as real estate agents, content providers, insurance services and more.
Notable brands include Coldwell Banker, Better Homes And Gardens Real Estate and Century 21.
Unfortunately, given the abrupt plunge in economic activity, Realogy has found itself in a bind. With few buyers willing to act during the stay-at-home period, transaction fees are few and far between. As a result, Realogy has had to slash costs; the CEO accepted a 90% pay cut, for example. The company also tapped a $400 million line of credit. Still, with RLGY stock down from $12 to $3.60, investors are clearly skeptical that Realogy will make it through okay.
If you are bullish on housing coming back more quickly than expected, RLGY could be a stock to pick up at rock bottom prices.
Home Depot (HD)
Finally, when you’re watching real estate, you should have an eye on Home Depot. As a hardware store, it may not be quite the first thing that comes to mind when you think of real estate stocks. However, Home Depot is closely tied to the home building and home repair industries. As a result, Home Depot is often the No. 1 or No. 2 largest holding within homebuilder industry exchange-traded funds.
Some analysts are already warning about HD stock given its housing exposure. On Wednesday, for example, Wedbush’s Seth Basham warned that HD stock is expensive and more levered to the cyclical sales than rival Lowe’s (NYSE:LOW).
Basham left Home Depot at just a neutral rating, saying that the stock is still expensive, even after its recent decline. With Home Deport at 20x earnings heading into a real estate market downturn, that’s a reasonable call to stay on the sidelines for now.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned First American Financial stock.