Arm’s-length plays on housing recovery

Just because investors were burned the last time around doesn’t mean they can’t take advantage of the housing market recovery.

Anyone with even a vague memory of the carnage triggered by the 2007 collapse of the real estate market probably isn’t ready to start leveraging, remodeling and flipping houses. But why not take advantage at arm’s length through the various industries and sectors that stand to benefit from an improving housing market?

“We’re seeing the housing recovery in the form of new-home sales, housing starts, construction permits, existing-homes sales, higher prices — and we’re even seeing it in the increase in pickup-truck sales,” said Brian Gendreau, a market strategist at Cetera Financial Group Inc. and professor of finance at the University of Florida.

Although much of the recovery to this point already has been priced into brand-name homebuilders such as Lennar Corp. (LEN), Ryland Group Inc. (RYL) and Toll Brothers Inc. (TOL), plenty of opportunities still are seen in the expansive periphery of the housing market.

“Some parts of the housing market have taken off faster than others, but there is clearly an underlying trend of improving strength,” said Dan Veru, chief investment officer at Palisade Capital Management LLC.

He cites, for example, regional banks that have picked up the pace of mortgage loans in this new era of more-responsible lending practices. Among his favorites is Fulton Financial Corp. (FULT), which gained 1% in 2012 but is up about 22% so far this year.

Extending even further from the direct housing play, Mr. Veru has a position in short-line railroad company Genesee & Wyoming Inc. (GWR), which gained 26% in 2012 and is up about 17% this year.

“They service the Pacific Northwest, where a lot of the lumber for building new homes comes from,” he said.

As we learned from the housing market bubble and ensuing financial crisis, the U.S. housing market’s web extends through nearly every aspect of the economy, in large measure because housing is so closely linked to consumer wealth and sentiment.

“It’s not just about the little corner of the economy we call housing; it’s about the big corner of the economy we call consumers,” said Bob Doll, chief equity strategist and senior portfolio manager at Nuveen Asset Management LLC.

In essence, with consumer spending representing 70% of the economy and housing representing the largest investment for most consumers, economists increasingly view housing as the lead engine of the economy.

“The most important part of the conversation is housing because it is so instructive for consumer sentiment and spending,” Mr. Doll said.

So it doesn’t really matter that Ryland Group rose 132% in 2012 and is up more than 27% this year.

The expansive housing web theory is why sales reports from big-box retailers such as Home Depot Inc. (HD) and Lowe’s Cos. Inc. (LOW) get so much attention.

Home Depot gained 50% in 2012 and is up about 29% this year. Lowe’s was up 42% in 2012 and is up more than 22% this year.

“Home Depot and Lowe’s are clear examples of where you go if you think the housing recovery has sustainability to it,” said Jim Russell, senior equity strategist at U.S. Bank Wealth Management.

But to get really creative with an indirect strategy, investors also should be thinking about companies such as Emerson Electric Co. (EMR) and General Electric Co. (GE), he said.

“The direct play of homebuilders can be a little spiky,” Mr. Russell said. “We prefer the indirect way when it comes to the housing market.”

Drew Wilson, an analyst at Fenimore Asset Management Inc., is focused on the increased turnover of foreclosed homes as a way to take advantage of the housing recovery.

“There are a lot of picks and axes in either construction or repair and remodel,” he said. “With foreclosures turning over, a lot of them have been poorly maintained, so they are going to need new paint and floorings.”

Mr. Wilson likes diversified floor coverings company Mohawk Industries Inc. (MHK) for that reason.

“It’s largely a repair-and- remodel story, but there’s also a lot of laminate and tile that is going into new homes,” he said.

Mr. Wilson is betting on Graco Inc. (GGG), a maker of commercial paint-spraying equipment.

“This might be a laggard part of the recovery because contractors will add sprayers later in the recovery and most still roll on paint, but this company is a market leader,” he said.