Stock Strategist

4 Undervalued Housing-Related Picks

Brian Bernard, CFA, CPA

The housing market slowed considerably during the second half of 2018 as persistently rising home prices and a sharp spike in mortgage rates pushed homeownership out of reach for more Americans. While that weakness persisted into the first quarter of 2019, there are signs that a rebound is looming amid a decline in mortgage rates and moderating home prices. New-home sales, which are counted when the contract is signed or the deposit is paid, are up 7% year to date through April; monthly home purchase mortgage application volume has outpaced the prior year since February; and the consensus among public homebuilders is that orders accelerated throughout the first quarter. As such, we expect total starts to grow modestly in 2019 to 1.255 million housing units.

Increasing headship and homeownership rates among millennials remain a key tenet of our housing outlook. More millennials are indeed forming households and buying homes, but we’ve been repeatedly disappointed by the rate of headship and homeownership gains for this large age cohort. While we previously expected a sharper increase in home purchasing as millennials seized upon favorable ownership conditions, factors such as student debt and underemployment have proved more stubborn than we originally expected, and tightened Federal Housing Administration lending standards certainly don’t help. For these reasons, we’re now projecting a more gradual climb in new-home construction, to over 1.4 million starts by 2025 (instead of our previous forecast of 1.6 million units by 2024), as demand is bottlenecked to some extent by financial constraints. We expect single-family starts will grow at over a 3% pace through 2025, reaching nearly 1.1 million. However, we think multifamily starts are near peak levels and will decline at a 2% compound annual rate through 2025 to 330,000 units, which is still above the 30-year average annual rate for multifamily starts. Over the next decade (2019-28), we’re now projecting 13.7 million cumulative starts, 7% lower than our previous forecast of 14.7 million.

 Lennar (LEN) (homebuilding),  Masco (MAS) (home products),  Canfor (CFP) (wood products), and  RH (RH) (home furnishings retailer) are our top housing-related stock picks this quarter. No-moat-rated Lennar, which is well positioned to benefit from increased demand from first-time buyers and its emerging multifamily business, has the widest margin of safety among our homebuilder coverage. A divestiture of narrow-moat-rated Masco’s cabinets and window businesses, either through a sale or spin-off, has the potential to create shareholder value and could be a catalyst for the stock. We expect management to conclude its strategic review of these two businesses in June. No-moat-rated Canfor, which offers a wide margin of safety, remains our preferred way to gain exposure to the lumber industry; the share class we cover trades on the Toronto Stock Exchange. Finally, we think shares of no-moat-rated RH have traded down in response to China sourcing exposure, which RH has been reducing since before the United States implemented tariffs. If the tariffs are rolled back, we would expect the share price to more accurately reflect the earnings power of the business.

Brian Bernard, CFA, CPA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.