Housing starts, or residential new construction, is one metric that can be used in conjunction with others to assess the overall health of the real estate market. When demand is high, construction activity is up. Until production meets demand, housing prices will rise. This is one reason real estate prices have remained strong despite concerns over impacts from the coronavirus crisis.
The United States is in a massive housing shortage. Freddie Mac estimates that there is a 2.5 million unit shortage for housing based on long-term demand. This shortage hasn't gone unnoticed by developers, who prior to the coronavirus pandemic had 1,536,000 units in development in January 2020.
New construction is back in a big way
The initial outbreak of the pandemic paused many development projects that were already underway and stopped a great deal from commencing, with April 2020 having a 30% decrease in housing starts when compared to January 2020 highs. But as the country starts to reopen, housing starts are on the rise as developers try to meet the current demand. The latest census report showed that new starts are on the rise for July, reaching 1,495,000, surpassing pre-pandemic levels.
While there still is some uncertainty in the market, it's likely this trend will continue upward until further demand for housing is met, meaning investors interested in participating in this growing sector should consider their investment options.
How to partake in the growing demand for development
Investors looking to partake in the growing demand and market for new developments have several options. Residential real estate investment trusts (REITs) that specialize in ground-up development of single-family homes for rentals like American Homes 4 Rent (NYSE: AMH) or Equity Residential (NYSE: EQR), who own and develop urban high-rise apartment buildings, are a great way to enter the development space with the added benefit of long-term leases and rental income to offset new development costs. American Homes 4 Rent completed 327 newly constructed properties in the past quarter with plans to continue expanding new construction through their AMH Development pipeline in their high-growth top-tier markets. Equity Residential has 1,045 units under development currently.
But rentals aren't the only way to meet demand. Investors can also purchase shares in real estate stocks like D.R. Horton (NYSE: DHI) or Lennar Corporation (NYSE: LEN) two of the largest single-family home developers in the world who focus on ground-up development of communities with the intentions of selling to end buyers.
D.R. Horton reported a 37% increase in net income per share and a 38% increase in net order increase at the end of the second quarter of 2020. They seem to be positioned well financially with a low debt ratio of 18.4% debt to total capital as of June 30, 2020. Lennar Corporation similarly has seen a 27% increase in earnings per share; however, revenues and current orders were down in Q2 2020 and they have a current backlog of nearly 18,000 homes. Their higher debt to total capital of 31.2% also puts them at a disadvantage when compared to D.R. Horton.
These aren't the only ways to participate in the current demand and increase in new development. There are other unique real estate investment projects like adaptive reuse or newly developed mobile home communities that will help produce the much-needed housing units for long-term demand, just in a new way. Before buying into any REIT or stock, make sure you do your due diligence on the company and are comfortable with their financial standing, projects underway, and management of current assets.