The residential real estate market finds itself in an uncertain place to finish out 2023. The Federal Reserve has gone on a dramatic rate hiking campaign as it seeks to stamp out inflation.
Many analysts had expected the Fed to finally pivot as inflation appears to be slowing. However, Chair Jerome Powell’s comments this week left the door open for another rate hike.
In any case, it appears unlikely that rates are coming back down in the near future. That, in turn, is likely to lead to a slump in the residential real estate market. Here’s how to stay safe and make a profit from the residential real estate market moving forward.
Mid-America Apartment Communities (MAA)
Real estate investment trusts (REITs) have been getting crushed this year. That’s due to rising interest rates, which have two negative effects on apartment REITs. For one, REITs usually use a lot of debt and will pay more in interest when they refinance their loans. And, for another, as yields go up, investors demand higher yields (and thus lower stock prices) on their REIT holdings.
All this has pushed down apartment REITs, such as Mid-America Apartment Communities (NYSE:MAA), in 2023. MAA stock is down about 15% year-to-date.
However, its underlying holdings of 101.986 apartment units should hold their value well during the current economic storm.
In fact, as people are increasingly priced out of being able to buy their own homes, we should expect to see more folks renting for longer. This should lead to steady demand for Mid-America’s units. That’s doubly true thanks to favorable demographics and underbuilding in the housing industry over the past 15 years. The housing market may be heading down, but counterintuitively, that could be good news for MAA stock.
With shares at 52-week lows, the stock now offers considerable value and a 4.1% dividend yield. This is a way investors can play the residential real estate market.
SPDR S&P Homebuilders ETF (XHB)
Homebuilders should be one of the biggest losers from high-interest rates and the downturn in the housing market. And yet, so far, the SPDR S&P Homebuilders ETF (NYSEARCA:XHB) is up sharply over the past year. Here’s why that won’t last, and, in fact, it’s time to sell XHB and other homebuilding stocks.
First, let’s understand why homebuilders have rallied. Ironically, people have gotten stuck in their existing homes due to rising interest rates. If a person has a 4% fixed rate mortgage on their existing house, they are unlikely to sell it and buy a new house with a 7.5% mortgage today. As a result of this dynamic, the supply of used houses has declined.
New homebuilders were able to fill that void with shiny new inventory. That explains why homebuilders have outperformed expectations so far. However, let’s not lose sight of the bigger picture. Average mortgage rates are above 7% and heading higher. This has slashed the average household’s prospective buying power.
As interest rates stabilize at far higher levels, the cold reality of the situation will sink in. If a household could afford a $500,000 mortgage at previously low-interest rates, perhaps they will only buy a $300,000 house now given the far higher monthly payments in the new interest rate landscape.
Homebuilding stocks were absolutely wrecked in the 2008 financial crisis. This is not a sector known for faring well during recessions. Investors should take advantage of the current rally in the XHB ETF and homebuilder stocks and get out before it’s too late.
First American Financial (FAF)
Title insurance is a unique form of insurance based on the deed for a house or commercial building. The title insurer investigates all potential claims against a property and guarantees that a house is being sold in good standing without any legal liabilities such as back taxes or conflicting wills that could invalidate a transaction.
What makes this niche so attractive is that most banks will only underwrite mortgages on properties with title insurance. In effect, it is a requirement to buy a house with a mortgage. That makes for a pretty strong competitive moat, especially as there are only five nationwide title insurers with meaningful market share. When people have to buy a good and the number of suppliers is limited, good profit margins tend to follow.
Title insurance takes much less market risk than, say, homebuilders. Unlike a homebuilder, the insurer doesn’t have to own land, deal with expensive construction materials, or end up with large amounts of potentially unsold inventory.
The title insurer is simply writing policies on homes entering a mortgage contract and taking a cut of that. A down housing market will temporarily limit profits, sure. But there’s minimal longer-term risk to the business’ fortunes; when transaction volumes pop back up, so do the title insurers’ profits. Another favorable point is that in a recession, rising foreclosures and forced sales generate additional demand for title insurance services.
A leading firm in the field is First American Financial (NYSE:FAF). Shares are going for less than 14 times forward earnings and offer a 3.6% dividend yield.
On the date of publication, Ian Bezek held a long position in FAF stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.