How to Profit From an Overheated Housing Market

An overheating housing market is not only causing some angst on Main Street, it’s been causing an all-out brawl on Wall Street – at least a war of words. But as is often the case, where there is turmoil, there is opportunity. There may just be a way to have your house – or apartment complex – and make money, too.
But before I get to how to profit in an overheated housing market, here’s some more on the Wall Street tug of war we’ve been seeing regarding housing:
Notable bond investor Jeffrey Gundlach, CEO of DoubleLine Capital, sent shock waves through the housing market earlier this year when he told investors to short homebuilding stocks.
At the Sohn Investment Conference, Gundlach said, “Single-family housing is overrated. Renting is more appealing across all age groups, all parts of the U.S., city, suburb, small town and rural.”
Famed Investor Bill Miller of Legg Mason has since come out and called Gundlach flat-out wrong. He points to housing affordability, which will eventually lure homebuyers back to the market.
Billionaire and real estate investor Sam Zell is on Gundlach’s side. Zell is the chairman of the nation’s largest apartment owner, thus he knows a thing or two about rental trends.
Zell digs a little deeper than Gundlach, noting that it’s about the lifestyle changes that will keep individuals and families renting. Most notably, it’s the deferral of marriage and delay of having children. Zell notes, “I don’t think the multifamily market has ever had a better set of future demographics.”
The current generation was previously forced to rent, but even as the lending market shows signs of loosening, they are choosing to rent.
Have we seen a permanent shift away from home ownership to home rental? Probably not. But we can certainly benefit from what seems like a growing trend right now.
REITs that focus on apartments and multi-family housing will turn out to be great investments. What’s more is that these companies also pay solid dividend yields, making them interesting income and growth plays. Here are two to consider:

Overheated Housing Income Stock No. 1: Equity Residential (NYSE: EQR)

This is Sam Zell’s REIT and the largest apartment owner in the U.S. Its dividend yield is right at 3.2%. It has nearly 400 properties and over 110,000 apartment units. It also happens to be one of the best-positioned REITs when it comes to desirable, high-end markets. Its key markets include southern California, Washington D.C., San Francisco, Boston and New York.
Catering to the high-end market helps insulate Equity Residential against a weak economy – when many individuals look to trade down, the more affluent Equity Residential renters can better ride out economic woes.
Additionally, many of the areas that Equity Residential operates within have a higher home ownership cost, such as Washington D.C. That means more people are likely to rent, making the markets that Equity Residential operates in “win-wins” for the company.

Overheated Housing Income Stock No. 2: Apartment Investment and Management Co.  (NYSE: AIV)

By market cap, Apartment Investment and Management Co. is about a fourth the size of Equity Residential, but it still offers a 3.2% dividend yield. Apartment Investment and Management Co.  owns just over 160 apartment communities, making up nearly 50,000 apartment units.
The company is also working down its debt and increasing liquidity. It had $195 million in cash at the end of the first quarter, compared to $167 million at the end of 2013. It also has $445 million available via its credit facility. Eight of its properties are now unencumbered by debt (compared to seven at the end of 1Q 2013), with an estimated fair value of $410 million.
As part of its effort to revamp its portfolio, it sells off 5% to 10% of its lowest-rated properties each year. It then reinvests those proceeds in apartment homes with higher rents and better margins.
While Gundlach recommends shorting housing stocks, shorting stocks can be a scary and risky investing strategy. Instead, investors can still profit by owning the major real estate rental companies. The two REITs above are a couple of the best plays on the generational shift away from home ownership.

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