You may be among the millions of Americans celebrating the National Association of Realtors (NAR) decision to repeal the old real estate transaction business model. The 6% commission structure, which attracted many to the profession of selling and marketing real estate, is now gone.
While this development represents an industry-wide cleaning for millions of agents and their commission costs, it creates plenty of opportunity for investors. While most brokerages will now have less of a budget to work on marketing efforts, those already at the top will continue to take market share. But it doesn't stop there.
Companies like the Zillow Group Inc. (NASDAQ: Z) will now be the go-to platform for these top brokerages to sponsor their property listings. This gives Zillow some extra pricing power for their advertising services. More than that, lower home buying costs could spur new activity, which is why mortgage originators like Walker & Dunlop Inc. (NYSE: WD) can also rake in additional profits.
Another group of real estate stocks that will benefit are real estate investment trusts (REITs) like Equity Lifestyle Properties Inc. (NYSE: ELS). These companies will see their net assets rise for two reasons. First, they will get a hold of more properties to manage. Second, they will collect rental income from or simply partake in the financing of the new residential demand boom that is to come.
The Buffett Effect
After buying up stock in construction names like D.R. Horton Inc. (NYSE: DHI) and others, Warren Buffett started a wave of curious analysts looking into the real estate sector for further trends and opportunities. While it's too late to get into the homebuilding names (they rallied too hard), you can still get into the lateral plays that will come about.
It turns out the old Oracle was right again. According to the Intercontinental Exchange Inc. (NYSE: ICE), most mortgages held today carry an average interest rate of 3.25%, so most homeowners are not looking to sell, especially now that mortgages are above 7%.
For this same reason, not many are willing to buy a house and take on such expensive financing rates. More than that, the average home price is now $492,300. This average price is up $107,700 from the average of $384,600 before the COVID-19 pandemic.
The only way to get out of this situation is to build more inventory, which could take some of the pressure off of home prices and mortgage rates. Buffett's bet was correct; however, there is still a long way to go until the trend ends.
A Full-Cycle Portfolio is Here
There must be a reason why Jefferies Financial Group Inc. (NYSE: JEF) and J.P. Morgan Chase & Co. (NYSE: JPM) recently got their analysts to upgrade Zillow stock. As of March, Jefferies sees a valuation of up to $75 a share for the real estate platform, calling for a net 53% upside from today's prices.
More than that, J.P. Morgan analysts stood by their January price targets of $65 a share, representing a 33% upside. Knowing what you know now, it should be no surprise that the market is also bidding up this stock.
Expecting 35% earnings per share (EPS) growth in the next 12 months is a good enough reason to pay a higher valuation in Zillow. For this reason, its forward P/E ratio of 21x stands at a 79% premium to the average valuation of real estate operations of 11.7x.
The party only starts there, as the second step after marketing a property on Zillow is the financing. Mortgage originator Walker & Dunlop is hopping on this bandwagon of bullishness, especially after Barclays (NYSE: BCS) bought up to $3.1 million worth of stock in February.
Wedbush analysts also see the wave coming, which led them to boost their price targets up to $130 a share in February. To prove these valuation targets right, the stock would need to rally by as much as 44% from today. Accepting these trends, the market also pays a higher price for this stock.
Expecting 30% EPS growth this year, analysts are leading the stock to trade at an 80% premium to the mortgage industry's average 8.8x forward P/E valuation. Walker & Dunlop stock went up to a 16x forward P/E valuation on its expected EPS growth despite a recent 22% dip.
Last but not least, Equity Lifestyle Properties is in this cycle portfolio. Barclays decided to buy up to $9.9 million worth of this REIT as of February; all the while, the stock suffered a 12% dip in the last quarter. Maybe expecting the dip to reverse on this significant industry trend, markets also see a higher ceiling ahead.
Trading at a forward P/E of 21.2x puts Equity Lifestyle at a premium of 40% to the residential REIT average valuation of 15.4x forward P/E. As the REIT takes on more properties under its portfolio, and real estate prices continue to increase due to new demand, the market will be proven right to pay a higher price for this one.
