Near-Term Outlook Bright for Real Estate Development Industry
Real estate development companies are mainly 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. Operations of these properties provide recurring revenue sources for companies.
Moreover, 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.
Before we delve into the details of the industry, 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:
Dovish Fed and Alternate Financing Options: The Fed’s dovish stance and lower mortgage rates will likely provide enough stimuli to fuel investment and boost development activities 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. Moreover, private lenders and real estate FinTech firms are being considered to meet capital needs, especially for riskier projects and lesser-known borrowers. 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.
Opportunity Zone incentives to drive investments: The Opportunity Zone program was created by passing 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.
Coronavirus Pandemic and Its Impact: However, the COVID-19 pandemic has affected all industries and economic uncertainties resulting from the outbreak have been escalating. There is an uncertainty regarding the extent and duration of the pandemic and associated government directives, economic relief measures, as well as capital market. Amid these, demand for lots and sale of properties will likely be adversely impacted in the near term. Apart from sales volume, top-line growth of the constituent companies of this industry might be affected as tenants struggle to make rent payments. Hospitality properties have already taken a hit due to cancellations, while retail properties are bearing the brunt, thanks to social-distancing practices and mandatory shutdown orders. Office and multifamily real estate markets are no exception, with demand for the same also likely to be hurt. Nevertheless, the cost-cutting measures and liquidity-bolstering efforts are likely to act as cushion in these trying times.
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 #17, which places it at the top 7% 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.
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 Finance Sector as well as the S&P 500 composite over the past year.
The industry has lost 40.9% during this period compared with the S&P 500’s decline of 4.6%. During the same time frame, the broader Finance sector has been down 17.6%.
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 11.53X compared with the S&P 500’s 18.11X. The industry is trading below the Finance sector’s forward 12-month P/E of 13.3X.
Over the past five years, the industry has traded as high as 32.69X, as low as 8.77X, with a median of 20.29X. This is shown in the chart below.
Forward 12 Month Price-to-Earnings (P/E) Ratio
In a nutshell, the pandemic’s adverse impact on the economy and supply-chain disruptions will hit the industry hard. However, low mortgage rates and the Fed’s dovish stance will likely spur real estate development activity in the near term.
Therefore, despite the crisis, currently, there are three top-ranked stocks in the Real Estate Development industry that are cashing in on the robust industry fundamentals.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Consolidated-Tomoka Land Co. (CTO) is a real estate company that enjoys the ownership of income properties consisting of more than 2.3 million square feet in diversified markets in the United States. The company primarily focuses on investing in multi-tenant properties in major U.S. markets. It flaunts a Zacks Rank of 1, currently. The current-year consensus EPS estimate moved 43.6% north to 79 cents in two months’ time.
Green Brick Partners, Inc. (GRBK): This publicly-traded company operates as a homebuilding and land development provider. It sports a Zacks Rank of 1, at present. The 2020 consensus EPS estimate for the company has been revised 37.4% upward to $1.58 over the past two months. The figure denotes 36.2% year-over-year EPS growth for the ongoing year. Further, it is likely to register earnings growth of 15.2% in 2021.
Forestar Group Inc. (FOR): 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 suggests a 27.9% increase year over year. Further, it is likely to register earnings growth of 23.3% in the next fiscal.
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