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Near-Term Outlook Bright for Real Estate Development Industry

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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 these properties.

Additionally, some industry participants actively undertake strategic activities, such as infrastructure improvement, along with land planning and development, in a bid to promote economic development, attract quality job creators and diversify the regions in which the companies operate. These firms 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 key 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 activities. Further, the three rate cuts by the Federal Reserve this year and two more expected in the next will likely provide enough stimulus to fuel investment and boost development activity in the upcoming period. Lower interest rates reduce the cost of borrowing money, encouraging owners and developers for taking out loans to develop land for construction. 
     
  • Opportunity Zone incentives to drive investments: The Opportunity Zone program was created by passing of the Tax Cuts and Jobs Act, aimed at incentivizing private investment in under-served 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 next several years, as developers keep hunting for assets and investment opportunities with solid upside potential. In fact, given the investor demand for real estate investments under the program, capital invested in this will likely emerge as an attractive financing source for real estate developers. Moreover, it might compel developers to shift their focus from high-income regions to these otherwise-blighted neighborhoods. 
     
  • Exploring alternative financing options: In light of heightening regulatory requirements in the mortgage market, 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 #16, which places it at the top 6% 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 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. Over the past eight months, the industry’s earnings estimate for the current year moved up 9.6%.

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 gained 4.7% during this period compared with the S&P 500’s rise of 13.2%. During the same time frame, the broader sector has been up 6.5%.

One-Year Price Performance




Industry’s Current Valuation

On the basis of the 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 20.77X compared with the S&P 500’s 18.21X. The industry is trading above the Finance sector’s forward 12-month P/E of 14.63X.

Over the past five years, the industry has traded as high as 32.69X, as low as 11.28X, with a median of 20.29X. This is shown in the chart below.

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




Bottom Line

The U.S. economy has maintained a bullish momentum, witnessing the longest ever expansion cycle in its history.  This slow and steady pace of expansion may extend the ongoing business cycle, making it ideal for real estate investors. Moreover, with demand for the residential and non-residential real estate space remaining robust, the larger picture of the industry looks impressive.

Further, rising consumer spending, solid job gains and muted inflation have supported consensus expectations for gross domestic product (GDP) growth rates. In fact, the Fed’s September forecast for U.S. GDP growth for 2019 and 2020 ranges between 2% and 2.5%, respectively. Thus, it may be a good idea to bet on this space right now, keeping expectations for 2020 in mind.

This apart, U.S. homebuilding rebounded in October, while permits for future home construction surged to a more than 12-year high. Specifically, building permits increased 5% sequentially to the current level of 1.461 million. This indicates solid growth witnessed by the construction projects in the nation compared with the multi-decade low of a meager 513,000 reported in March 2009. This construction boom brings good news for land developers.  

Thus, we expect the Real Estate Development industry to fare well amid combination of healthy construction activities, robust property fundamentals, low interest rates and resilient economy.

Here, we present three stocks that sport a Zacks Rank #1 (Strong Buy) and are well positioned to shine in the near term. You can see the complete list of today’s Zacks #1 Rank stocks here.

Green Brick Partners, Inc. (GRBK - Free Report) : The publicly-traded company operates as a homebuilding and land development provider. The 2019 consensus EPS estimate for the company has been revised 4.8% upward to $1.08 over the past month. The figure denotes 16.5% year-over-year EPS growth for the ongoing year. Further, it is likely to register earnings growth of 12% in 2020.

Price and Consensus: GRBK




Forestar Group Inc (FOR - Free Report) : The company operates in two business segments — real estate and natural resources. The real estate segment owns real estate directly or through ventures. The natural resources segment manages acres of oil and gas mineral interests. The Zacks Consensus Estimate for fiscal 2020 EPS has climbed 4.5% to 91 cents in the last month. It is also expected to record earnings growth of 15.2% and 4.4% in fiscal 2020 and 2021, respectively.

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 current-year consensus EPS estimate moved 38% north to 83 cents in a week’s time.

Price and Consensus: HHC




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