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As Housing Heals, Are Mortgage Stocks A Good Bet?

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A weak jobs report Friday at least briefly blurred views of a U.S. economic recovery that had appeared to be staging slow yet steady gains. But interest rates and inflation remain low. That points to better days ahead for real estate, a sector which no doubt has lots of upside given how hard it got slammed in the financial crisis and Great Recession, right?

Not so fast.

Yes, the residential housing market is improving. By several metrics, it's recently regained highs last seen before the downturn. Steadiness, if not quite strength, and expectations for the traditionally cyclical business to rebound, have helped lure investors into real estate-related stocks. That, in turn, helped lift the Financial-Mortgage and Related Services industry group to No. 8 on Friday among the 197 industry groups tracked by IBD.

Many stocks in the group are risky, and many of the companies operate within dramatically shifting markets. The entire group faces uncertainty about exactly how Washington plans to handle some of the open questions about housing that linger from the crisis. The industry also includes some, likeOcwen Financial ( OCN ), which have been dogged by questions about corporate practices. Still others, like industry leaderLendingTree ( TREE ) and federally-managedFannie Mae ( FNMA ) andFreddie Mac ( FMCC ), are either thinly traded or the darlings of powerful institutional players.

A Battle Among Data Providers

Group leaderCoreLogic ( CLGX ) gets beyond some of those questions by straddling a wide footprint in two important areas: data analytics and mortgage origination. That gives the Irvine, Calif.-based company both a cyclical and a secular edge, according to Jason Deleeuw, an analyst with Piper Jaffray.

Piper has an overweight status on the stock and a price target of 48, which would represent about a 30% bump from where it traded on Friday.

The data and analytics portion of CoreLogic's business, which is the "secular" component Deleeuw referred to, powers about 60% of its earnings, he said. It includes everything from reporting on the most effective loan originators in specific geographic markets to tracking levels of distressed sales.

CoreLogic also owns the closely-watched Case-Shiller Home Price Index, and has developed other price indexes of its own. That's a growth area, according to Keith Gumbinger of mortgage information provider HSH.com. "There's a long train of opportunity in terms of a much greater level of more granular, better, more frequent analytics," Gumbinger told IBD.

It's not clear who has the better data, CoreLogic or close competitorBlack Knight Financial Services (BKFS), Deleeuw said, but CoreLogic's data segment generates about $500 million in revenue, while Black Knight's generates $200 million.

CoreLogic also provides mortgage transaction services like tax monitoring for servicers and flood-zone data reporting. That means it's benefiting from a rising tide in mortgage originations, which have notched double-digit year-on-year gains for the past two months, according to data from the Mortgage Bankers Association.

The company also has made cost-cutting a priority and has "greatly improved cash flow conversion," Deleeuw said.

Morningstar analyst Brett Horn agrees with that assessment, although he's a little less bullish on the stock. "We think the outlook is bright for CoreLogic as it moves past trough market conditions and benefits from meaningful cost efficiencies," Horn wrote in a recent note. "However, we think that outlook is fully reflected in the stock price at the moment."

The Private Insurer Question

In contrast, private mortgage insurerNMI Holdings (NMIH) may not be for the faint-hearted. It's the smallest player in the private mortgage insurance market and sometimes seems to pale in comparison to a better-positioned, more diversified competitor,Essent Group (ESNT).

Essent benefited from being the first player to emerge just after the financial crisis when "legacy" insurance companies likeRadian (RDN) were in trouble, BTIG analyst Mark Palmer told IBD. "The window of opportunity had, to a certain extent, closed by the time NMI came around," he said, and when NMI shares failed to follow the same explosive trajectory that Essent enjoyed after its IPO, "a lot of the enthusiasm had been drained out of the story."

But NMI still has a lot going for it, Palmer says. He's expecting it to grow and break even in 2016 -- better than consensus views calling for a 10-cent per-share loss. For one, it's one of only two investment-grade-rated insurers in the private market. Essent is the other. NMI also passed a federal regulatory test to continue doing business with Fannie and Freddie, although it will need to raise more capital in the future.

NMI has also proved nimble in making itself more attractive to originators, Palmer said. One way is by expanding the "sunset" period, the time period in which coverage of a particular buyer can be rescinded if a mistake was made in the underwriting process, to about two to three years, up from the normal industry standard of one year.

Still, questions remain. Private insurers now make up 15% of the overall mortgage insurance market, and it's unclear whether more business will shift their way. The Obama administration's pick to run the Federal Housing Finance Agency, Mel Watt, has been less supportive of such a transition, and there may be little clarity on policy until a new administration enters the picture in January 2017.

The Apartment, Offices Angle

HFF (HF) taps the real estate story while bypassing many of the nagging questions about housing regulation. The Pittsburgh-based company provides commercial real estate services and capital market services to the commercial real estate sector across the country.

HFF has a wide reach across multiple areas, but mostly specializes in apartments and offices. That's important because each of those markets is in a different stage of the economic cycle, said Brandon Dobell, an analyst at William Blair, who calls HFF "well-positioned" and maintains an "outperform" rating.

"In the apartment space, we're probably in the 8th inning just because it's been strong since 2008," he said. But for office space in most nonpremium markets, like Minnesota or the suburbs of Chicago, the cycle has a lot more room to run.

HFF is keenly aware of the cyclicality of its business, and careful about how it manages cash flow, Dobell said. A key metric: How productive is its workforce in making deals? Because it has such a wide reach, HFF can be either careful or aggressive about adding people in very specific areas.

"It's a transactional business and it's a little challenging trying to predict deal flow quarter to quarter," Dobell said, "but we continue to think the stock is quite attractive both near-term and medium-term."

For HFF, the macroeconomic environment may be the biggest question mark. As Dobell noted, it's not clear when the next downturn will come and companies will no longer need to expand into new offices, or whether the Federal Housing Finance Agency will take a step back from the multifamily market. Rising interest rates could be a slight headwind, although the Federal Reserve is likely to go very slowly with that process.

One other consideration: Commercial real estate returns have tumbled from the 9%-10% they were hitting a few years ago. But investors can still count on returns of about 5%-7%, Dobell said.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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