3 Stocks to Take Advantage of Surging Home Prices

Homeowners have been in for a pleasant surprise during covid-19. Against the backdrop of historically low interest rates and plummeting supply, home prices skyrocketed during the pandemic.  

According to the S&P CoreLogic Case-Shiller Index, home prices soared 11.2% over the prior year in January. 

(Crazy stat: This is the strongest yearly return for home prices since February 2006.)

However, there’s a belief this is no bubble due to increased bullishness around strong post-pandemic economic activity and forecasts of moderate inflation. 

The pandemic had a psychological effect on many millennials with many trading in cramped city apartments for suburban homes with stay-at-home amenities like yards, decks, and home offices. 

The financial media triumphantly declared 2020 “the year of the stay-at-home stock” yet oddly overlooked an important part of the phrase.

(Hint, it was the other asset in the term: home.) 

3 Top Real Estate Stocks for 2021 

As a result, many investors overlooked this nascent but long-term trend and put their money solely in high-growth stocks, mostly in the tech industry, like Zoom Technologies, Peloton Interactive, Shopify, and Teladoc Health. 

Understandably, now these companies have fallen out-of-favor with investors due to the stretched valuation metrics and investors are looking for the next great idea. (Side note: all these companies have great business models still but remain expensive for the current market backdrop). 

However, investors should pay close attention to the “home” trade. The long-term trends turning renters to home buyers and the wealth created by homeownership will remain after the pandemic. 

However, there’s more to real estate than homebuilders and construction companies that are often cyclical in their operations and have unreliable profitability prospects. At the same time, at Millennial Money we’re interested in companies that are future proof or are working to disrupt traditional industries. 

Here are three stocks to benefit from increased home prices with long-term potential. 

Home Depot Is a lower-risk Amazon-proof retailer on discount

The Home Depot (NYSE: HD)
Market Cap: $347 billion
Revenue Growth: 19.8
Stock Price: ${{ price }}

Even with 58% returns for the last 1-year period, Home Depot has underperformed many of its peers. The SPDR S&P Retail ETF is up 173% in the same period as investors are increasingly bullish on the prospects for retailers as more venture out and shop.  

That’s our opportunity. Currently, Home Depot is now trading nearly on par with the greater index on a forward-earnings basis – 25 vs. 23 – despite being in a stronger position than most retailers. 

While 20% growth last year was impressive, it’s likely you will see revenue growth decelerate this year as analysts expect the company will grow its top line approximately 3%.

That’s ok. Long-term value investors can count on Home Depot’s shareholder-friendly capital policies which currently consists of a 2% dividend yield and approximately half of its $15 billion of its 2019 share buyback authorization. 

The bearish narrative holding shares back is the pandemic drove Home Depot’s top line into overdrive and sales will significantly decline as homeowners spend money on vacations and out-of-home activities. 

It’s too early to say, but traditionally Home Depot stock has performed well in environments where home prices are increasing and should also join traditional retailers in higher in-person sales as America reopens. 

Do-it-yourself sales will benefit from rising home prices as many homeowners choose to renovate versus “trading up” and the “wealth effect” of higher home valuations gives homeowners the confidence to spend more money on upgrades and appliances. 

Additionally, low supply and high prices will encourage professional homebuilders to increase construction, which will drive spending both directly and indirectly through their legions of contractions. Additionally, Home Depot has a nonresidential driver in the form of the Biden Administration’s $2.25 trillion infrastructure bill. 

Retail is a cutthroat industry with many companies at risk of ecommerce disruption, most notably Amazon. However, Home Depot is not at risk from the threat of ecommerce due to the unique nature of its products and the community workshop atmosphere makes the user experience sticker and less prone to disruption. 

Despite that, Home Depot is trading nearly on par with the greater retail industry. Long term investors would be well suited owning shares of Home Depot. While the stock has been on a run since early March, long-term investors in the company are still positioned to be rewarded from today’s prices. 

Redfin is changing the market from within

Market Cap: $7.1 billion
Revenue Growth: 14
Stock Price: ${{ price }}

Unsurprisingly, last year was a strong year for Redfin. Overall, the company grew its market share and was the most-visited brokerage site in the fourth quarter of 2020. Still, there are reasons to think the company is just getting started as it still has a miniscule market share of 1%.

Redfin aims to change the homebuying process from within. Currently, homeowners must deal with significant costs to buy or sell a home in the form of commissions, closing fees, and upgrade costs often amounting to 12% of the sale price. This is suboptimal on account homes are often the highest-cost item a consumer will ever purchase. 

Enter Redfin: the company was founded to use technology and scale to drive down commissions on their side to 1.5%, half of the typical 3%, while initially working within the existing realty framework. 

However, what’s increasingly interesting to investors is the company’s RedfinNow operations. With RedfinNow the company transacts directly with sellers, buying homes with the intention of selling them directly to buyers. 

Sellers like the quick closing times and are often willing to take less in price to avoid the fees and upgrade costs and this allows Redfin to monetize its top-notch data and make targeted bets in certain housing markets.  

Admittedly, there’s risk in moving from representing brokerage agency to dealer. The most apparent is the company is now holding inventory on its books, which exposes Redfin to the risk of housing prices. The company is wisely only operating in a few markets where it has significant data and strong outlooks and attempts to sell inventory quickly to limit any potential risk. 

Additionally, the company is not the only operator in the “iBuying” space, facing competition from a host of tech startups most notably from the recent SPAC Opendoor Technologies (see below). Redfin’s background and hybrid model of traditional operator — along with having the highest-trafficked real estate site — gives it a powerful moat to operate in this space.  

Redfin is a higher risk name than Home Depot but has a potentially longer runway for growth. Additionally, Redfin is not a cheap stock. The company trades at 7.5 times sales and barely produced positive cash from operations in full-year 2020. 

However, long-term investors with moderate to high-risk tolerances should investigate the company. In the end, the real estate market in the United States is large and a disruptor like Redfin should continue to win market share for years to come. 

Opendoor Technologies is a high-risk but potential disruptive force in real estate

Opendoor Technologies (NASDAQ: OPEN)
Market Cap: $11.4 billion
Revenue Growth: (46%)
Stock Price: ${{ price }}

Ecommerce is taking over the world and has disrupted traditional retail and even grocery. To date, however, larger consumer purchases still have not been disrupted by the internet. Notably, the automotive and homebuying markets still have entrenched processes designed to enrich middlemen at the expense of customers. 

These middlemen – along with the increased fees and complexity they add — have the additional effect of hurting homeownership, particularly among potential first-time buyers. Making the homebuying and selling process less costly with fewer steps has the potential to drive new consumers much like no-commission trading apps has done for stock trading. 

Redfin and Zillow are looking to automate various facets of the process and are increasingly adopting the iBuying business model but Opendoor is the only company that utilizes iBuying as their primary transaction type. That’s both an opportunity to benefit from higher home prices and a potential risk if home prices fall.

For a 5% fee, homeowners can list on Opendoor like a traditional brokerage firm. However, Opendoor also acts as a dealer and offers the option to sell direct to them for 5% of the offered price, which eliminates the headaches associated with traditional home sales including real estate agents, repair work, and open houses. 

While that sounds expensive for a direct sale, selling to Opendoor further eliminates tangible costs like broker commissions, closing costs, mortgage carrying costs, and seller-concessions. Opendoor has a major believer in the form of Chamath Palihapitiya: the “SPAC King” took the company public through his Social Capital Hedosophia Holdings Corp. II SPAC in December 2020.

That’s great for potential sellers but the risk then transfers to Opendoor investors and down markets could lead to a raft of “underwater sales” and impact profitability. There’s a risk in strong markets as inventory tightens and prevents the company from picking up new homes to sell.

Essentially, this is what happened in 2020. The tight housing market — along with a decision to pause home acquisitions — during covid homes put pressure on its top line. 

Additionally, there is both risk and opportunity in the company’s growth plan as it plans to double the number of markets to 42 this year alone to be the iBuying market leader and ensure Redfin is relegated to second-place in this nascent industry. The phrase “all housing is local” is apt as the company will have to adjust to the nuanced demand and supply for more areas. 

Provided they can manage inventory better than they did during covid, the upside potential is significant. Opendoor is sitting on the ground floor for decades of growth as it continues to disrupt the trillion-dollar housing industry. 

Investors should treat Opendoor as a speculative investment and ensure they have a long-term timeframe of at least three to five years before committing capital. 

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Eric Bleeker has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Home Depot and Opendoor Technologies Inc. Millennial Money is part of The Motley Fool network. Millennial Money has a disclosure policy.

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