The Zacks Real Estate – Development industry is poised to gain from the rising demand for a number of property types and unleashing of pent-up demand. The pandemic-induced behavioral changes of consumers offer scope to reconsider the optimal usage of real estate. Apart from these, real estate developers are striving toward digital transformation at job sites and in back offices, which will go a long way in enhancing operational resilience. Amid this, The Howard Hughes Corporation HHC and Forestar Group Inc. FOR are expected to benefit from the favorable trends and ride the growth curve.
However, the industry is likely to feel the brunt of rising interest rates, inflationary pressure and macroeconomic uncertainty, which have an adverse impact on buying power. Along with higher mortgage rates, multiple disruptions in the supply chain are resulting in a shortage in construction materials, leading to a rise in material costs.
About the Industry
The Zacks Real Estate – Development industry includes companies that 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. Some industry participants actively undertake strategic activities, such as infrastructure improvement, along with land planning and development to boost economic development, attract quality job creators and diversify the regions in which the firms operate. These firms provide real estate leasing, stewardship, underwriting, planning and entitlement services. Real estate development companies are chiefly classified as financial ones, not construction firms.
What’s Shaping the Future of the Real Estate Development Industry?
Improving Real Estate Market Makes Room for Growth: The values of a number of property types, including industrial and apartment, have been experiencing improvement over the past quarters. Moreover, with the waning of pandemic-related concerns, the pace of deterioration in other asset categories has moderated considerably. In fact, with the unleashing of pent-up demand, a number of these property types have started rebounding, which is likely to fuel the pace of property price growth, and keep the market buoyant. Demand for retail real estate spaces in high-traffic corridors is also improving as retailers that are able to beat the pandemic blues are now eyeing expansion. Also, demand for mixed-use assets is gaining momentum. These offer ample opportunity to real estate developers to continue undertaking new projects. Additionally, digital transformation efforts to optimize operations will continue to be a key focus.
Evolution of Real Estate Use to Drive Development Activities: Real estate developers are well poised to capitalize on consumers’ behavioral changes triggered by the pandemic. The e-commerce boom and supply-chain strategy transformations are continuing to drive demand for industrial spaces. Moreover, return-to-office strategy and flight-to-quality are likely to accelerate development activities for offices and other in-demand real estate categories in the coming quarters. Hence, we do not anticipate a reduction in development activities.
Rising Interest Rates, Inflation and Market Uncertainty to Affect Business: Rising interest rates, the inflationary environment and market uncertainty are likely to have an adverse impact on this industry’s performance. This is because such factors weigh on buyer sentiment and impact buying power. As a result, many potential buyers are either pausing or reconsidering their purchase decisions. This is causing a delay in the closing timeline for transactions. Moreover, as interest rates are hiked to tame inflation, there is a reduction in credit availability. This combination of less available and more expensive debt is also affecting transaction activities. Debt markets are adhering to a cautious stance and there is also an increase in underwriting requirements, affecting transaction activities. However, the choppy environment will likely provide scope to a number of industry players to bank on growth opportunities and consolidate market share.
Supply-Chain Woes and High Material Costs to Impact Business: Multiple disruptions in the supply chain are causing a crunch in construction materials, in turn prompting a rise in material costs. The shortage of skilled labor has added to the woes. These supply-chain issues and tightness in the labor market are lengthening the development cycles in a number of markets. Until the global supply chain constraints ease, continued cost inflation and building material shortages are likely to persist.
Zacks Industry Rank Indicates Bright Prospects
The Zacks Real Estate Development industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #97, which places it in the top 39% 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 the 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 year, the industry’s earnings estimates for the current year have been revised 5.5% upward.
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 Underperforms Sector and S&P 500
The Zacks Real Estate – Development industry has underperformed the S&P 500 composite and the broader Finance sector over the past year.
The industry has declined 26.4% during this period compared with the S&P 500 composite’s fall of 17.3% and the broader Finance sector’s decline of 11.5%.
Industry’s Current Valuation
On the basis of the forward 12-month price-to-earnings (P/E), which is a commonly-used multiple for valuing real estate development companies, we see that the industry is currently trading at 7.24X compared with the S&P 500’s 17.49X. The industry is trading below the Finance sector’s forward 12-month P/E of 13.43X. This is shown in the chart below.
Over the past five years, the industry has traded as high as 44.40X and as low as 3.70X, with a median of 16.32X.
2 Real Estate Development Stocks Worth Betting On
Forestar Group Inc.: This residential lot development company focuses on investments in land acquisition and development. The major portion of the company’s real estate projects is single-family residential communities.
Despite the uncertainty in the market, Forestar Group, with its strong balance sheet and ample liquidity, is expected to strengthen market share in the fragmented and under-capitalized U.S. residential lot development industry.
FOR carries a Zacks Rank #1 (Strong Buy) at present. The Zacks Consensus Estimate for fiscal 2023 EPS has been revised 6.1% upward to $2.77 over the past month. The company’s shares have rallied 36.8% so far in the quarter.
You can see the complete list of today’s Zacks #1 Rank stocks here.
The Howard Hughes Corporation: The company owns, manages and develops commercial, residential and mixed-use properties throughout the United States. Its assets include a portfolio of master-planned communities, other operating properties and development opportunities.
With its expertise in the real estate sector, the company is well poised to bank on the post-pandemic shifts in the residential and commercial real estate trends. The company’s 2022 revenues are projected to be up 8.42%.
Analysts seem bullish on this Zacks Rank #2 (Buy) stock. The Zacks Consensus Estimate for the 2022 EPS has been revised marginally upward over the past two months. Moreover, the Zacks Consensus Estimate for 2023 EPS has been revised upward to 91.9% over the same period. The stock has appreciated 39.5% so far in the quarter.
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