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Opportunities Brewing for Real Estate Development Stocks

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Real estate development companies are primarily engaged in owning, developing and managing a variety of real estate properties, including commercial, residential and mixed-use parcels. While some developers undertake construction on their land holdings to eventually sell the properties to homebuilders, retaining the same for conducting operations is also a common practice. These companies generate recurring revenues by operating the properties.

Additionally, some industry participants actively undertake strategic activities, such as infrastructure improvement, along with land planning and development, to promote economic development, attract quality job creators and diversify the regions in which they operate. They also provide real estate leasing, stewardship, underwriting, planning and entitlement services.

It is worth noting that real estate development companies are primarily classified as financial companies, not construction companies.

Here are the three major themes in the industry:

  • Stable economy and dovish Fed: A decent U.S. economy, low unemployment levels and high consumer sentiment are vital growth catalysts for the industry. This is because during periods of economic growth, business expansion spurs demand for office space, retail centers, hotels, residential apartments and other commercial realties, leading to higher development activity.  Further, the Federal Reserve chairman Jerome Powell’s indication about interest-rate cuts, should the need be, can fuel investment and boost development activity in 2019. Additionally, lower interest rates can reduce the cost of borrowing money, encouraging owners and developers from taking out loans to develop land for construction.  
     
  • Opportunity Zone incentives to drive investments: The Opportunity Zone program was created through the passing of the Tax Cuts and Jobs Act, aimed at incentivizing private investment in underserved and low-income areas across the United States, in exchange for a hefty tax break. In response to this, trillions of dollar investments are anticipated to be deployed in these zones over the upcoming years as developers continue to hunt for assets and investment opportunities with solid upside potential. In fact, given the investor demand for real estate investments under the program, capital invested under this will likely emerge as an attractive financing source available to real estate developers. Moreover, it might compel developers to shift focus from high-income regions to these otherwise-blighted neighborhoods.  
     
  • Exploring alternative financing options: In the light of constrained mortgage environment, market contraction and increasing regulatory requirements, banks are becoming reluctant to provide construction loans and financing. Alternatively, private lenders and real estate fintech firms are being considered to meet capital needs, especially for riskier projects and lesser-known borrowers. Particularly, real estate FinTechs provide platforms for firms to expand and diversify their lender base, thus, enabling financing and investment in development projects. In addition, developers can use these platforms for a variety of services, like leasing, acquisition, disposition decisions, and obtaining detailed financial models for property construction financing.

Zacks Industry Rank Indicates Promising Prospects

The Zacks Real Estate – Development industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #96, which places it at the top 38% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential. Since the beginning of the year, the industry’s earnings estimate for the current year has moved up 8.2%.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags on Stock Market Performance

The Zacks Real Estate – Development industry has lagged the broader Zacks Finance Sector as well as the Zacks S&P 500 composite over the past year.
The industry has declined 17.6% during this period compared with the S&P 500’s rise of 5.7%. During the same time frame, the broader sector has been down 0.2%.

One-Year Price Performance




Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing real estate development companies, we see that the industry is currently trading at 15.31X compared to the S&P 500’s 17.37X. The industry is trading above the Finance sector’s forward 12-month P/E of 14X.

Over the last five years, the industry has traded as high as 49.78X, as low as 10.95X, with a median of 19.52X. This is shown in the chart below.

Forward 12 Month Price-to-Earnings (P/E) Ratio




Bottom Line

Notably, high prices and market saturation in first-tier cities have been compelling developers to consider second-tier markets for projects. In fact, Apple Inc. is opening a billion-dollar campus in Austin, and Amazon has announced Northern Virginia, just outside Washington, D.C., as the site for its second headquarters. We anticipate that as big names flock to second-tier cities, it will also propel growth in development activities and a strong influx of capital in these markets.

Furthermore, real estate developers can no longer deny the overwhelming impact technology is having on the industry. Real estate technology is well equipped to address a number of concerns ranging from affordable housing challenges, long-term labor shortages, to productivity woes. Although implementation of new technology requires considerable time, money and human resources, it is helping companies identify investment opportunities and counter industry headwinds, thus enhancing risk/return profile. Hence, this year, we project high levels of tech adoption to spread to smaller firms, as construction tech becomes critical across the industry.

Sentiment has been shifting toward the favorable side for homebuilders, powered by the retreat in mortgage rates, a reacceleration in home sales and home-construction activity. Amid these, LGI Homes, Inc. (LGIH - Free Report) and Forestar Group Inc. (FOR - Free Report) are well poised to excel.

The Zacks Real Estate – Development space doesn’t currently have stocks that sport a Zacks Rank #1 (Strong Buy). However, we present a stock from the same industry, holding a Zacks Rank #2 (Buy), and two stocks carrying a Zacks Rank #3 (Hold), which are well positioned to shine in the near term. You can see the complete list of today’s Zacks #1 Rank stocks here.

Consolidated-Tomoka Land Co. (CTO - Free Report) : This Zacks Rank #2 company is primarily engaged in the real estate industry through its wholly-owned subsidiaries. Real estate operations include commercial real estate, real estate development, property leasing, residential and golf operations, leasing properties for oil and mineral exploration, and the sale of forest products. The 2019 consensus EPS estimate for the company has remained unchanged at $8.20, over the past month. The figure denotes 16.5% year-over-year EPS growth in the ongoing year.

Price and Consensus: CTO




Forestar Group Inc: This Zacks #3 Ranked company operates in two business segments — real estate and natural resources. The real estate segment owns directly or through ventures real estate. The natural resources segment manages acres of oil and gas mineral interests. The Zacks Consensus Estimate for 2019 EPS is pinned at 60 cents. Further, its projected long-term earnings growth rate 13.7%.

Price and Consensus: FOR




The Howard Hughes Corporation : The company operates as a real estate company engaged in the development of master planned communities and other strategic real estate development opportunities across the United States. It operates its business in two lines of business — Master Planned Communities and Strategic Development. The company carries a Zacks Rank of 3, at present. The current-year consensus EPS estimate has remained unchanged at $3.94, over the past month. This denotes a year-over-year surge of 198.5%.

Price and Consensus: HHC




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