Where to invest in housing: Rent or own?

The U.S. home ownership rate is now at its lowest point in nearly half a century, which has investors asking if that’s by default or choice?

Certainly the recent recession has left fewer young Americans in a position to afford home ownership, but the argument is equally strong that young millennials, as well as downsizing baby boomers, prefer the financial and physical flexibility of renting. So which is the better bet: stocks of the nation’s homebuilders or stocks of multifamily real estate investment trusts (REITs)?

Read More Homeownership rate drops to lowest since 1967

Single-family home construction is still well below historical norms, but multifamily apartment construction is soaring. It begs the question, why are the stocks of single-family builders faring better than REITs, and are investors missing the boat?

Comparing year-to-date, stocks of big builders like Lennar up 16 percent, DR Horton up 16 percent and Toll Brothers up 13 percent, are arguably beating those of REITs like Avalon Bay up 5 percent, Equity Residential up 3 percent and Essex Property Trust up 8 percent.

Strong growth in apartment construction in the past three years has had investors nervous that the nation is on the verge of an oversupply of units, which could lead to lower occupancy and lower rents. Rents and occupancies are currently hovering at historic highs. There is a strong argument, however, that multifamily construction was next to nothing during the housing boom, and these new units are making up for that pent-up demand.

“Apartments have gotten a second wind,” said Alexander Goldfarb, a REIT analyst with Sandler O’Neill. “Fundamentals are likely to remain elevated for the next few years.”

Apartment REITs that reported earnings this week outpaced expectations, even those of their own CEOs.

Read More More homeowners drowning in debt

“Our results for the second quarter and year to date exceeded our original outlook. For the balance of the year, we expect accelerating apartment demand to support stronger performance across our business,” noted Avalon Bay Chairman and CEO Tim Naughton in the company’s earning’s release.

On the flip side, some investors believe the nation’s home builders are well positioned for a long road of growth ahead. Housing supply is incredibly low on both the new and existing side, given population growth. Still, the home builder market seems a bit stickier and more dependent on location and price point. Builder earnings out this week showed some weakness in new orders, prompting some to question if higher mortgage rates and higher home prices in general might be taking their toll on buyers.

“Among builders, DR Horton is taking market share hand over fist, and WCI is crushing it with active-adult product in Florida,” said Buck Horne, a builder analyst with Raymond James. “But then you have some builders that are stagnant in a saturated move-up market, like Pulte and Ryland.

Both single and multi-family home builders are both being constrained by a tight labor market, but their cost of capital is easing, as real estate overall is a popular investor play. Both will benefit from an improving economy and employment picture. Single-family builders should see more demand as Millennials marry and have children. The multi-family REITs may be better positioned geographically.

Read More Housing supply falls further, feeding prices

“If you look at the economic recovery, it’s hard to look at the numbers and go ‘Wow.’ It hasn’t been off the charts. But if you look at the areas where people are getting jobs, it does neatly line up with where a lot of the REITs are,” said Goldfarb.

Perhaps the best bet is to buy both, as both appear to have room to grow. The key, however, as with any asset, is to know the product well.

“You really just have to be very selective across the spectrum—focused on special situations, unique catalysts, or company-specific market share opportunities. There are opportunities, but in this environment, I don’t think you can throw a blanket ‘buy’ call on one sector versus the other,” said Horne.

This entry was posted in Personal Finance, Real Estate. Bookmark the permalink.

Leave a Reply