What Happens to the Housing Market if Interest Rates Rise? 7 Stocks to Watch

Stocks to Watch - What Happens to the Housing Market if Interest Rates Rise? 7 Stocks to Watch

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With rate hikes from the Federal Reserve just around the corner, what’s next for housing? On one hand, when it comes to stocks to watch in the housing space, it appears the market is bracing for the worst.

That is, shares in homebuilders and real estate brokerages currently trade at single-digit price-to-earnings (P/E) ratios. The takeaway is that after strong operating performance during 2020 and 2021, investors expect lower earnings in 2022 and 2023. Stocks in companies operating in other areas of the housing economy may not be selling at such fire-sale valuations. But while still richly-priced, they have also experienced big declines since the start of the year.

However, it’s not definite that rising rates will bring the housing boom to an end. At least, not immediately. Some commentators have argued the housing market responds slowly to changes in interest rates. Others make the argument that housing isn’t in a bubble, and rising home prices are being driven by demand outstripping supply. As this continues, concerns about rising rates and their impact on housing may be overblown.

In short, as the impact of rate hikes is unclear, expect things to remain uncertain. This could create opportunity when it comes to investing in these seven housing stocks to watch:

  • Cavco (NASDAQ:CVCO)
  • D.R. Horton (NYSE:DHI)
  • Home Depot (NYSE:HD)
  • Invitation Homes (NYSE:INVH)
  • Opendoor Technologies (NASDAQ:OPEN)
  • Realogy (NYSE:RLGY)
  • Zillow (NASDAQ:Z, NASDAQ:ZG)

Stocks to Watch: Cavco (CVCO)

A photo of a person looking at a cell phone with the Cavco logo on the screen.

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Although as said above, many homebuilder stocks are selling at super-low prices, that’s less the case here with CVCO stock. Sure, a P/E ratio of 15.2x isn’t exactly high. Yet compare it to the 6.9x P/E of D.R. Horton (more below), and it appears this stock has a super premium valuation.

So, why does Cavco sport such a high P/E? Much of it may have to do with how it’s not a traditional homebuilder. Instead, it’s a builder of manufactured homes, also known as mobile homes. As regular single-family home prices skyrocket, more Americans have been turning to lower-cost alternatives to put a roof over their heads.

This has resulted in tremendous growth in Cavco’s revenue and earnings over the past year. Last fiscal year (ended April 2021), the company generated around $1.03 billion in sales. Earnings per share (EPS) came in at $8.34. This fiscal year, analysts project $1.56 billion in sales and EPS of $20.36. With this, this stock’s valuation and the fact it’s only increased in price 25% over the past twelve months may signal it has more room to run.

Or does it? While the sell-side projects a big jump for fiscal 2022, the company is expected to see minimal earnings growth. As revenue is expected to go up again, this is due more to inflation putting pressure on margins. CVCO stock has already moved lower in response to this, falling from a high of $327.24 per share late last year to around $280 per share. It’ll be interesting to see how changes (if any) in the housing market affect its performance going forward.

DR Horton (DHI)

In this photo illustration the D.R. Horton (DRI) logo seen displayed on a smartphone.

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America’s largest homebuilder, DR Horton, has benefited greatly from the pandemic-era housing boom. It’s on track to generate $35 billion in sales this fiscal year (ending September 2022), up from $19.7 billion in sales during fiscal 2020.

As a result, DHI stock has experienced a big jump in price. Back in March 2020, when “lockdown mode” kicked off, it fell to prices under $30 per share. In December, just when rate hike fears were emerging, it was trading for as much as $110.45 per share. Down moderately since then, and at around $86 per share today, it may seem like the ship has sailed when it comes to profiting from the housing boom.

Yet with its super low P/E ratio, it’s possible the market is overestimating to what extent the housing market is going to cool as 2022 plays out. Back in January, UBS analyst John Lovallo argued that “if demand doesn’t buckle,” homebuilder stocks like this one could surge again as the market realizes it has priced them too low.

Of course, “if demand doesn’t buckle” is the key phrase here. Recent headlines suggest that the supply and demand dynamic will stay out of whack for longer than expected.

However, per famed financial commentator Gary Shilling, homebuilders may actually cause the housing market to experience its “party’s over” moment. Ramping up production, the talking heads saying housing isn’t in a bubble could soon be proven wrong.

Stocks to Watch: Home Depot (HD)

the outside of a home depot store

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At first glance, you may wonder why I’m including this retailer on a list of housing stocks to watch. But as my InvestorPlace colleague Joel Baglole put it a few months back, general contractors and construction companies make up a large part of its customer base.

As such, the housing boom has had a big impact on the performance of HD stock since 2020. Even after dropping around 22% year-to-date, shares still trade for twice what they were trading for when the pandemic started. However, that’s not to say it’s necessarily bottomed out.

At least, that’s the view of one Seeking Alpha commentator, who recently opined that a cooling housing market and high inflation could put big pressure on Home Depot’s profitability going forward. In turn, that could cause the stock to experience another drop to $290 per share. Changing hands for around $324 per share today, admittedly that’s only a moderate drop of about 10.5%.

Still, if you were mulling a purchase of it after the recent pullback in price, you may want to wait before you make this Dow Jones Industrial Average component a buy. Down the road, if pessimism about housing ratchets up further, there could be an overreaction that pushes HD stock to a more ideal entry point.

Invitation Homes (INVH)

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Invitation Homes is another name that’s a housing stock, but not one directly involved in the construction or sale of new homes. Rather, it’s a real estate investment trust, or REIT, that owns and rents out single-family homes.

A tight housing market of course has been a boon for this big-time landlord and investors in INVH stock. This is yet another name that’s delivered a very high return during the pandemic era. The big jump in rental prices has resulted in solid results, with management projecting a double-digit percentage increase in its funds from operations (FFO) for 2022.

But while things still seems to be going well for Invitation Homes, more challenging times may lay ahead — and not just from the possibility that “experts” have it all wrong about limited supply and skyrocketing rental rates. The fallout from a whistleblower lawsuit alleging the REIT cheated cities in Southern California out of fees and property taxes could a greater impact on its stock price than currently expected.

There’s also growing backlash about the increased institutional ownership of residential housing stock. As I discussed when talking about one of Invitation’s peers, American Homes 4 Rent (NYSE:AMH), politicians on both sides of the aisle are lambasting this trend as bad news for middle-class Americans. This is something else that could put pressure on INVH stock, which at around $39 per share today is down only slightly from its all-time high of $45.80.

Stocks to Watch: Opendoor Technologies (OPEN)

The Opendoor (OPEN) website is open on a smartphone that is resting on top of a map.

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When talking about housing stocks to watch, you can’t ignore Opendoor, a leading name in the iBuyer space. iBuyers, which are basically digital house flippers, purchase homes using algorithms for pricing. After fixing them up, they flip them for a small profit.

With the sharp rise in housing prices, investors were excited about OPEN stock and its business model when it went public in late 2020. As a result, this former special purpose acquisition company (SPAC) spiked up to prices above $30 per share. Yet between the SPAC wipeout last spring and the cycling out of growth stocks on rate hike fears, it’s since dropped below its original $10 per share SPAC price.

Yet even at less than $8 per share, it’s too early to say that it’s hit rock-bottom. For one, it’s still expensive using traditional valuation metrics. Potential future growth remains too heavily factored into its stock price. Even worse, its success in the next year or two hinges entirely on the housing market remaining as hot as it’s been during 2020 and 2021.

Otherwise, if housing cools, Opendoor could find itself stuck with too many houses that it winds up having to sell at a loss. It would be similar to what happened to Zillow (more below) after its ill-fated move into iBuying.

Realogy (RLGY)

Residential neighborhood subdivision skyline Aerial shot

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Realogy is an “old school” name within the housing economy. The company owns realtor franchises like Century 21 and Coldwell Banker. Languishing at penny stock levels two years ago, the early-2020s housing boom has enabled its shares experience a tremendous rebound in price.

But after zooming back to double-digit prices, since last summer, RLGY stock has found itself stuck between $15 and $20 per share. Like with the homebuilders, investors seem to be pricing in a big slow down in Realogy’s shares. As a result, it too trades at a very low earnings multiple of 6.4x.

Sure, you can see this and right off the bat declare it a value trap. If the more bearish case for housing plays out, there’s a high chance it won’t be earning anywhere near what it’s been earning over the past year. In turn, it will see a move to much lower prices.

However, if you believe demand for housing will stay high despite rising rates, this may be one of the stocks to watch to make that wager. With low expectations priced in, if housing stays resilient like with homebuilder stocks, investors could re-rate its valuation. A recently announced share repurchase plan, which will buy back up to 14.4% of outstanding shares, could help lift it higher as well.

Stocks to Watch: Zillow (Z,ZG)

zillow app icon on a mobile phone

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If you’ve been following Zillow, you know it’s been a rough past few months for the digital-first real estate services company. This is mostly due to the fallout from its failed move into iBuying. As you may know, the company banked its future on beating out Opendoor to become the larger iBuyer by market share.

But putting market share over profitability, the company made a big mistake. It bought too many homes, and paid too much for them. With the post-pandemic labor and supply shortages affecting its ability to flip these homes profitably, last November it decided to throw in the towel. In the process it took a $550 million write-down.

This decision also led to an immediate plunge in the Z and ZG stock prices. Shares have struggled since then. Why? As Louis Navellier has pointed out, without its iBuyer segment, the company has little in the works to re-accelerate growth.

With overall growth slowing down, it may even have more room to fall from here — especially if rate hikes do affect housing demand, hurting the performance of its core listing and lead generation segments. It’s best to hold off on it now at around $55 per share. But you may want to keep an eye on it, as a further drop could push it to a more worthwhile entry point.

On the date of publication, Thomas Niel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.

Article printed from InvestorPlace Media, https://investorplace.com/2022/03/7-stocks-to-watch-housing-market-interest-rates-rise/.

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