Three Ways to Play the Great Real Estate Rebound

This article published with permission from InvestmentU.com.

Numbers reported earlier this month continue to support the growing belief that the real estate market is on its way back

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slowly but surely.

Standard & Poor’s reported that home prices in its S&P/Case-Shiller 20 City Index rose 0.9% from April to May of this year. If you do all the seasonal adjusting, that’s an increase of about 2.6% from the beginning of the year.

The Joint Center for Housing Studies at Harvard University in its annual State of the Nation’s Housing Report summarized the current market in these terms:

“Housing markets are showing signs of reviving. While still in the early innings of a housing recovery, rental markets have turned the corner, home sales are strengthening, and a floor is beginning to form under home prices. With new home inventories at record lows, unless the broader economy goes into a tailspin, stronger sales should further stabilize prices and pave the way for a pickup in single-family housing construction over the course of 2012…”

What’s even more striking is that its managing director stated in the report that inventories of new, single-family homes in March were at their lowest point in nearly a half century. This means that it would take less than six months to sell all of it. A five- to six-month period is considered a balanced market.

With this budding rebound in housing, let’s not sell ourselves short. There are other ways to take advantage of a real estate comeback than just single-family homes.

Over the last few months, I’ve searched for some of the best ways to play a rebound in real estate. Here are three of the most popular…

1. Start with the homebuilders

If we believe we’ve reached a bottom in the market, there’s data to show we could be reaping the benefits of a recovery for years to come. The International Monetary Fund found that on average, after home prices hit rock bottom, the rebound lasted about seven years. They found this to be true in the 55 housing rebounds worldwide over the last five decades.

Also keep in mind that little tidbit about the new single-family home inventory period. Well, with that period signaling a decrease in home supply, it gives homebuilders a bit of optimism.

If you add low interest rates to this equation, you could be looking at a good amount of growth in the industry going forward. Think of big companies like Lennar (NYSE: LEN), which may be best suited to handle an increase of demand. The company is also diversified and can take advantage of any boom in real estate.

If you’re more of a mutual fund or ETF investor, you probably want to take a look at the iShares Dow Jones US Home Construction Index Fund (NYSE: ITB). As of earlier this month, it was up 35% for the year. But be careful, because you may have already missed the run. As I mentioned last month, you can also consider the SPDR S&P Homebuilders (NYSE: XHB). This ETF has broad exposure to housing-related stocks. The index is up over 20% since opening the year at $17.44.

2. The investor turns landlord

It seems like such a logical step, but when you think about it, it can come with all types of risk. But there’s a strong case for being a landlord. I just mentioned that the homebuilders have seen a run-up this year; however, the prices of single-family homes haven’t. That’s an opportunity.

When in the purchasing process, keep in mind:

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Cash is king. If you have it, you can most likely negotiate a better price.

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Most banks are able to give investors funding for investment properties if they have that magic 30% down payment on the property.

According to some measures, home valuations are near a 14-year low. Some big wigs in the market like Warren Buffett are well aware of this. That’s why he’s been planning to bid on the loan portfolio of failed mortgage lender Residential Capital. Others are being more creative.

For those who want to play in the single-family housing market but don’t want the headaches of dealing with tenants, an alternative is on its way.

Back in the spring, private-equity firm Kohlberg Kravis Roberts (NYSE: KKR) and homebuilder Beazer Homes (NYSE: BZH) announced that they will go public with a REIT that will own and manage single-family homes. Look for this to be a trend with other investment managers in the near future.

3. REITs, REITs, REITs!

There are two types of real estate investment trusts (REITs): equity and mortgage REITs.

Equity REITs own real estate. They buy and manage commercial and rental properties. And primarily concentrate on profits by means of acquisition and management.

Mortgage REITs own debt. They invest in mortgages on real estate properties. And have the property only as collateral for the loans in which they invest.

Make no mistake. I’m referring to equity REITs, and they’re up 15% in 2012 after dividends.

To quote Rick Ferri, Founder of Portfolio Solutions, “… investors should put a hefty chunk of their portfolio in REITs because most commercial real estate isn’t publicly traded, so broad stock market funds grossly understate the sector’s importance to the economy…”

Frank Haggerty of Duff & Phelps Investment Management Company adds, “REITs that will benefit most from an economic turnaround will be those with shorter lease terms that can quickly raise rents, making those that own hotels, apartments and storage units the strongest players. High-quality mall properties also will fare better in a slowly expanding economy….”

The simplest way to get in the REIT market would be fee-friendly index fund. A good fit would be the Vanguard REIT ETF (NYSE: VNQ). You’re looking at an expense ratio of 0.10% and a dividend of about 3.3%. With the dividends, it’s up 17% for 2012.

If everything is cyclical as they say, investing now may put you in on the ground floor of a six to seven-year boom.

Jason Jenkins is a part of the research team at InvestmentU.com. See more articles by Jason here.