Should You Diversify Your Portfolio With Housing Stocks?
This is a reprint of a Bigger Pocket Post from Matt Mayre
Finding a good deal in the current real estate market can be pretty difficult. Prices are maxed out in most markets and sellers are getting bombarded by offers, many of which are above asking.
The science of investing tells us that buying near the top of a market is never a good strategy. The whole “buy low, sell high” idea is not confusing, yet it’s often disregarded.
In this real estate market, many active and soon-to-be active real estate investors are questioning if purchasing a property in these conditions is a valuable move—and ultimately, that’s for them to decide. However, as investors, we must consider all of our options and ensure our portfolios are diversified.
That brings me to the topic of the day: housing stocks.
The state of real estate
Let’s talk for a moment about what the real estate market looks like right now.
Prices are still appreciating, demand is still exceptionally high, materials are still expensive despite lumber costs finally dropping, would-be buyers are getting priced out of the market each day, inflation is rising, and the looming possibility of the Fed removing its training wheels from the economy have all pushed real estate into a box.
Plus, eviction moratoriums have been in place over the past year and a half, and there are sure to be more legal fights as the Supreme Court just ruled the eviction ban unconstitutional.
So while the ultimate “safe bet” might be an investment in real estate, we have cause to search for more liquidity in times like these. Fortunately, accessing the stock market is as easy as opening up a brokerage account and getting started.
But why housing stocks?
Housing stocks have done well
For one, if we look at Forbes’ theme of housing stocks—which consists of building product companies, home improvement stores, and home builders—we can see that the index has grown by 30% year-to-date.
That’s a whole 11% faster than the S&P 500, which happened to hit a record high last week.
Companies like Home Depot (HD) have experienced a tremendous surge in stock prices since the beginning of the COVID-19 pandemic. On March 4, 2020, just before the pandemic, Home Depot shares were selling at about $251 per share. Today, they sell for a little over $325.
The reason? Home improvement and DIY projects have amplified. Homeowners were tied to their homes during quarantine and found a whole host of problems and potential improvements. With the cost of materials soaring, taking bids from contractors became much more expensive, leading to more DIY projects.
And the housing stock boom doesn’t end at Home Depot or Lowe’s. Construction companies like Lennar Homes (LEN) have accelerated in stock growth, rising 42% year-to-date.
It seems contradictory. We’re facing a severe shortage in homes, and housing starts are still treading the bottom. The good news is that housing starts actually ticked up, albeit slightly, in July. This is a positive after two months of decline.
The greater question is how construction companies can still appreciate while the surge in building costs causes construction contracts to slow to a crawl. Many point to the fact that inventory is way below where it needs to be—meaning that the deficit of homes will allow builders to have a constant stream of new contracts to come, regardless of pacing. This naturally leads to sustained business.
Whether their stock prices are inflated due to sheer speculation or intrinsic value is for investors to decide. With lumber prices falling back to pre-pandemic levels and the overall growth of the stock market pressing onward, there are plenty of reasons to believe housing-related stocks will continue to appreciate.
Strong diversification is strong defense
There’s a lot of uncertainty in the economy and the world right now. The Delta variant of COVID-19 is rampant. Questions about the Fed’s monetary policy are in question—despite assurances that asset purchases will continue through the year to ensure the economic recovery remains on track.
In times like these, it’s best to have a portfolio of many asset categories that can withstand the downward pressures of an economy on the rocks. Real estate is always considered a safe bet, but acquiring a new property right now means you’ll likely be paying more than you should.
On the contrary, while stock investing might come with greater risks, it’s critical to remember the liquidity of stocks and the ability of select securities to outpace inflation. (Speaking of inflation, the White House just announced last week that inflation would rise 4.8% in Q4, up from a much more conservative 2% projection made in May. For investors, protecting your dollar is extremely important.)
Increasing buying power by riding the wave of stock prices can be a good way to set yourself up for a time when home prices begin tapering off and demand begins to settle down.