An impending housing shortage in some parts of the U.S. has created an investment opportunity that is largely unrecognized by Wall Street analysts. I reviewed Tim Siegel’s ebook Profit from the Coming Housing Shortage back in January, and now I am reflecting on how his investment thesis is playing out.
The difficult thing about being a value investor like Tim is that you are never certain how long it will take the market to begin recognizing the value that you see. If you are right about the stocks, but invest too early, it can destroy your track record for a couple of years. However, when the market finally begins to see the value in your stocks, the gains can be quite large and can continue for years. The last two years have indeed been difficult for Tim, resulting in a less than outstanding two year track record.
However, over the past 10 years, Tim’s model portfolio has returned almost 15% per year, which is roughly 7% a year better than the S&P 500. Further, in the last six months, he has been up 11%, ahead of the S&P 500 by a little more than 3%, which indicates to me that the market may be starting to recognize the value in Tim’s stocks.
You can view Tim’s top five holdings, learn more about his strategy, and track his progress with monthly Performance Insights emailed directly to you at the end of each month by visiting our website.
Ken Kam: Tim, your portfolio has done well over the last six months, but the latest reports show that U.S. homebuilders confidence levels remain at a low level in April after falling sharply back in February.
Tim Siegel: Homebuilder surveys indicate that homebuilders are not very optimistic, that’s true. However, the situation is quite different for small homebuilders than it is for large homebuilders. At present, only the large homebuilders can get financing. Because of this, the small ones have a reason to be pessimistic. There are many more small homebuilders than large ones in the U.S., so the polling is likely skewed toward the larger group of pessimistic homebuilders than the smaller group of homebuilders who are able to get financing right now.
Ken Kam: I see. The two homebuilders you recommended in January have not done well since we published your recommendations. Since we last talked, Pulte Homes (NYSE:PHM) is down 7%, and DR Horton (NYSE:DHI) is down 3%.
Tim Siegel: This is because prices have not yet started to reflect the improved business results of the large national homebuilders that operate in the parts of the country that are growing.
Ken Kam: You also recommended two real estate investment trusts (REITs) which have done well. Avalon Bay (NYSE:AVB) is up 17% and has a 3.4% dividend yield. Equity Residential (NYSE:EQR) is up 12% with a 3.3% dividend yield.
Tim Siegel: The market trades these REITs like bonds, comparing their dividend yields to interest rates on other bonds. But there is a critical difference I believe. If rents go up, these companies will be able to increase their dividends. A bond does not have that flexibility, so in a way, these companies are like bonds but with inflation protection.
Ken Kam: It does seem that higher rents have been the main driver of inflation.
Tim Siegel: Shelter is the single largest component of the Consumer Price Index (CPI), comprising 32% of the total. As of February, year-over-year shelter costs are up 2.6%, the largest such annual increase since mid-2008. This bodes well for investments like REITs that benefit from rising rents. With rents rising and interest payments set at historically low rates, these REITs should be able to generate more cash and increase their dividends. This makes them an attractive alternative to bonds because bonds do not increase their payouts no matter how well the issuer does.
Ken Kam: You also recommended American Residential Properties (NYSE:ARPI). This REIT is down 1% and hasn’t paid a dividend yet.
Tim Siegel: American Residential Properties has a net accounting loss so they are not required to pay a dividend yet. However, they specialize in buying and renting single family homes. After the global financial crisis of 2008, the prices of single-family homes in many parts of the country crashed. ARPI has been buying distressed, single family homes at bargain prices, rehabbing them, and then renting them out. Another company I like that does the same thing is American Homes 4 Rent (NYSE:AMH). Both of these companies are benefiting from rising rents, but they also have the potential for major capital appreciation as the properties they bought at distressed prices rise in value as housing shortages start to appear. The other two REITs will also see their property values increase, but they did not purchase most of their properties at firesale prices as ARPI and AMH did.
Ken Kam: Thanks for the update, Tim.
Conclusion: If you did not buy distressed property after the financial meltdown in 2008, you can still participate in the gains of two companies that did. Both AMRI and AMH did just that, and their balance sheets value their properties at their acquisition prices, which are close to the post-crash lows. Both stocks should do well as real estate prices recover and rents rise.
The older REITs do not have as many undervalued assets on their balance sheets, but their cash flow (and thus dividends) are more seasoned and will likely grow as rents rise. If you have significant exposure to mid to long term bonds, it probably makes sense to replace some of those holdings with seasoned REITs. If interest rates rise, as many expect they will, mid and long term bond prices will fall, but these REITs can maintain their value if rising rents enable them to increase their dividends.
The homebuilders are still lagging even for the largest firms where business seems to be improving. The market may be paying too much attention to opinion polls in which many small and pessimistic homebuilders might be overshadowing improving conditions for the large, national firms. Eventually the market will reward the ones that deliver the results.
Clients in our SMA program at Marketocracy own these stocks because they have allocated a portion of their account to Tim Siegel’s model portfolio. You can view Tim’s top five holdings, learn more about his strategy, and track his progress with monthly Performance Insights emailed directly to you at the end of each month by visiting our website.
Connect with Ken Kam on LinkedIN.
Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
