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3 Housing Areas to Watch

We're optimistic about housing demand, and think investors should keep their eyes on undervalued wood product, home improvement, and homebuilding companies.

Charles Gross: Although growth in housing construction fell short of our expectations in 2016, we believe tight labor markets, rising wages, and reasonable property prices will lead to rising demand in 2017.

Over the past year, single family construction grew by roughly 10%, while multifamily construction fell by 3%. In total, construction on nearly 1.2 million properties began. In 2017, we see that pace advancing to roughly 1.3 million units, and believe construction activity will rise to 1.9 million in 2020.

We're optimistic about housing demand for two reasons. The first, is that the finances of young adults have been improving since early 2015. With unemployment rates at what the Fed would consider normal, we've seen increased competition for labor, leading to rising inflation-adjusted wages. All else equal, this means young adults have more money to pay down student loans or begin renting and owning homes. As these financial constraints ease, we expect more households to form as fewer people live with parents or roommates.

The second reason is that there are indications of rising household formation. Over the past 12 months, vacant homes as a percentage of the total housing stock have been in decline. Given that demand for houses is represented through occupation of both existing and new homes, this suggests that underlying demand already exceeds 1.3 million units.

We also believe affordability looks reasonable. Rents are acceptable, while ownership is downright cheap. Rental rates have outpaced household income growth over the past few years, leading to reduced affordability among young adults. Thankfully, builders have responded, and new multifamily units are leading to a deceleration in rental rate growth, which should allow incomes to catch up in the coming years. Ownership, however, is cheap by historical standards. Today's low rate environment has made mortgage payments on a new or existing home substantially cheaper than it was 20 years ago on an inflation adjusted basis.

While the recent rise in equity prices has reduced the number of bargains, we encourage investors to keep their eyes on undervalued wood product, home improvement, and homebuilding companies for ways to play a strengthening housing market.

Charles Gross does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.