Tuesday, August 23, 2011

Building New Homes Ain't Like It Used To Be

In real estate shopping, you want the house with the best potential for your family and best deal for your money in the perfect neighborhood. In investing you want the stock with the most potential for your money, in the best market. Because let's face it in a bear market, even good stocks can head south. So, the question is which house to I want to live in?

Real estate in the US will always be part of the American Dream. New home construction will always exist. Brokers will sell houses. People will make fortunes off of flipping houses. And investment trusts will continue to use low interest rates to their advantage.

The biggest challenge for the market is how will companies need to change their business model to adapt to a post-bubble environment. This challenge exists regardless of their position in the market. Whether they be Builders, Suppliers, Brokers or Property Managers the way of doing business, selling, and making money in real estate is changing.

As I see it there are 3 essential elements of change for companies in the real estate industry to survive.

1. They need to be focused on the core customer, those that will still act even in a downturn.
2. They need to reconfigure pricing, across the board real estate operates at a discount. That means everyone needs to lower their fees, their margins, and their expectations. Doing business at a low margin is more valuable than not doing business.
3. Cost controls - during the boom this industry was plagued by out of control costs. The companies that are able to reduce costs and still operate will be the ones that succeed through the time of change.

So, where do the investing potential hide?

Well there are some in every industry. One that caught my attention over the past few days was Pulte Group, Inc. They are a new home / community building company. They are attractive for two main reasons:

1. Recent debt downgrades have caused their already beaten stock to stumble.
  PHM is now trading at a new post-crash low.

2. Cost-cutting and unique market creating measures have allowed them to regain lost ground. They now have a forward P/E of 13.9 and EPS for Next Year of $0.26 a share. This could become an amazing value over the long-term.

Investing in PHM could be tricky, the short-term may still be dicey and the stock itself could become very volatile over the next few months. I would plan on holding this one into 2012. Selling long-dated covered calls that are slightly out-the-money at a 1:2 options to stock ratio. (Assuming you go with the January Calls) That way you may have a 6% downside cushion but could still make 50% of the returns above and beyond $4.

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