Foreclosures and the Unexpected Bright Side
by Mike McDermott
It’s no secret that national homebuilders are facing a crisis of epic proportions…
A stubbornly high unemployment rate has kept demand for new and existing homes under pressure. As homeowners have found themselves increasingly unable to meet the mortgage obligations, foreclosure rates have skyrocketed.
The banks and other mortgage companies now have their hands full (and more than a little dirty) processing these foreclosures – and at this point there are so many foreclosed homes on the market at distressed prices that it is increasingly hard for traditional homebuilders to compete.
Sure, there are some home buyers who are dead set on buying a new home… But with so many foreclosed properties being sold by banks – many are very attractive properties at incredible bargains – why would someone pay a premium price for a new home built in a yet-to-be-finished development?
For the last several years, the majority of homebuilders have been bleeding red ink as the drop in sales has been matched only by the persistent decline in the market value of properties held by these developers.
But for some residential real estate participants, the environment is actually supportive of healthy revenue growth along with strong pricing power. Ousted homeowners have to live somewhere and for many, rental property including apartments is the only opportunity still available…
Rising Demand for Apartments
In a sign that the nation’s foreclosure crisis is taking a toll, renters surged into the U.S. apartment market in the third quarter, pushing up rents and driving down vacancies.
The national vacancy rate fell to 7.2% in the third quarter from 7.8% the second quarter, one of the sharpest drops on record, according to New York-based real estate research firm Reis Inc. Rents increased 0.6% to an average of $980 a unit over the same period as landlords were able to cut back on free rent and other incentives that had been used to attract and retain tenants in a weak market.
Economists said they expected the trend to continue. Former homeowners who lost their properties to foreclosure are now pouring into the rental market. Meanwhile, tightened credit standards are making it tougher for potential buyers to qualify for a home loan, despite low interest rates.
Housing Crisis a Lift for Rentals – Los Angeles Times
From a trading perspective, it appears that a very good case can still be made for shorting the homebuilders as foreclosures and unemployment continue to relentlessly pressure the US consumer. But as a counterbalance to our bearish bias on housing, there are a few rental property investments that look attractive.
More than just a “hedge,” a long position in these securities offer absolute profit opportunity while still helping to offset some of the broad risks associated with short positions in homebuilding stocks. Of course, price action is one of the key determining factors when pulling the trigger on a position, but a number of setups appear ready to cross inflection points which gives us a chance to enter the trade with our risk properly managed.
Post Properties (PPS) is trading at the highest level since the fateful fall of 2008. Analysts expect Funds From Operations ((FFO)) to hit $1.30 per share this year and $1.40 next year. More importantly, the company was recently able to extinguish a portion of its debt for roughly 64 cents on the dollar – and the gain should be reflected in the company’s third quarter report.
A dividend yield of roughly 2.7% isn’t excessive by any means, but it could make the stock more attractive to long-term investors who would be paid relatively well as they wait for the stock to appreciate in response to stronger rental conditions.
Analysts are expecting significant improvements in revenue, operating income, and occupancy trends, (click on chart to see larger image) which should help instill strong investor confidence.
Of course we’re not long-term investors – but as Mercenary Traders, we want to own the stock at key inflection points to capture the best returns with the most attractive risk profile.
It appears that the $30.00 area has emerged as a key resistance area and if the stock were to break above this level, it could attract attention from momentum players while offering us a chance to stop out a long position below the consolidation from the last week of trading. (click to enlarge)
The company will not report earnings until November 1, but the stock is likely to react to competitors announcements and industry trends well before management discloses it’s third quarter report.
Equity Residential Property Trust (EQR) beat analyst expectations this summer when it reported Q2 FFO of $0.58 per share and modest sequential revenue growth. More importantly, management increased guidance for the remainder of the year.
The company is actively engaged in improving its apartment holdings, acquiring several properties in the second quarter while selling another less profitable property it owned through a joint venture. Having the financial flexibility to pursue these transactions should lead to improvements in FFO, but also raises concerns due to the company’s heavy debt load.
After trading in a wide range all Summer, EQR broke to a new recovery high in September and has spent the last month consolidating that gain. We still have a few weeks until the company announces Q3 performance (the press release should be issued October 28) but I would be interested in buying a break above the tight range from the last week. (click to enlarge)
Avalonbay Communities (AVB) is a bit more expensive than competitors (using the traditional price / FFO metric) – but the company has been growing revenue more consistently than competitors which likely justifies the premium price. AVB is actually generating a higher yield – near 3.3% – which again makes the stock more appealing to long-term investors.
The company focuses on luxury apartments – and there is some debate as to whether this demographic is likely to do well or poorly as foreclosures continue to discourage homeowners.
The homebuilders continue to be on my short radar with stocks like KB Home (KBH) barely showing any strength in September (and beginning to roll over in October) and stronger names like Lennar Corp (LEN) and Toll Brothers (TOL) simply rallying into resistance areas.
Trading the homebuilders from the short side and apartment firms from the long side should offer absolute opportunity on both concepts while helping to offset some volatility as the two sides counterbalance exposure to residential real estate.
Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.
Recent Blog Posts:
Popular Blog Posts:
Subscribe to our RSS