Real estate is in a complicated position right now. On the one hand, it appears that interest rates have already peaked for this cycle and are set to start declining in the coming months.
In fact, the Federal Reserve has suggested that there could be multiple rate cuts in 2024, depending on how the economy and inflation evolve this year. I recently highlighted three real estate stocks that should benefit if and when interest rates go down.
On the other hand, the Federal Reserve is likely to cut interest rates for good reason. The economy may be losing steam. Credit quality metrics are slipping as consumers are facing economic strain. Globally, economies such as China are really struggling right now. And sectors such as travel and consumer discretionary that had been booming are now weakening dramatically.
There is a concept of long and variable lags in monetary policy; it can take many months between when the Fed raises rates and when it causes an impact on the economy. The Fed’s aggressive rate hike campaign is likely to cause major economic distress for parts of the economy in 2024. These housing market stocks appear to be in grave danger if the economy really slips later this year.
Hovnanian Enterprises (HOV)
At first glance, Hovnanian Enterprises (NYSE:HOV) looks like a tremendous value stock. This small homebuilder is trading at five times trailing earnings, 0.3x revenues, and less than 4x enterprise value to free cash flow (EV/FCF).
The company’s earnings have positively skyrocketed over the past few years as consumers rushed to buy new houses from 2020 onward. Hovnanian, as a small and highly leveraged firm, had a ton of torque to raise new home prices. Indeed, HOV stock exploded from $20 at the start of 2020 to $160 per share today. Even so, shares still look dirt cheap, right?
The problem is, however, that these earnings are likely unsustainable. Hovnanian has historically had a decidedly mixed record as a homebuilder; the firm lost money outright in 2015, 2016, 2017, and 2019. In 2017 alone, the company lost more than $56 per share in earnings. That’s not a misprint.
It’s easy for investors to look at Hovnanian during the recent housing boom, see the $30 per share or so in annual earnings, slap a high P/E multiple on it, and think HOV stock should double or triple. However, Hovnanian historically has wildly uneven earnings and it has a large debt load. If the more challenging housing market causes Hovnanian’s sales to slow, the company could see its earnings dry up and the share price plunge back toward where it was prior to the onset of the pandemic.
Opendoor Technologies (OPEN)
Opendoor Technologies (NASDAQ:OPEN) is a FinTech firm that is aiming to disrupt the housing market. It was founded on the idea of applying software and big data analysis to real estate transactions.
Opendoor purchases homes that its proprietary system identified as good values and then attempts to flip them for a higher price. If the system had worked as anticipated, this could have been a tremendous business model.
Alas, Opendoor has had significant problems attempting to run this formula at scale. The company repeatedly ended up selling homes at a loss. Overall, the firm has been generating negative adjusted EBITDA on its business, which is never a great sign for a publicly traded company.
What’s worse is that house-flipping is a capital-intensive business; homes aren’t cheap after all. This makes Opendoor far riskier than a pure-play software company that doesn’t have to invest much in tangible assets. As Opendoor’s AI model showed significant faults, the company scaled back its operations. Revenues plunged a stunning 71% year-over-year last quarter while the operating losses continued to pile up.
It’s troubling that Opendoor apparently couldn’t make money flipping homes during a huge housing boom. Now that housing prices are turning downward, Opendoor’s ventures look even riskier. As the final kicker, insiders repeatedly sold shares of OPEN stock throughout 2023.
Rocket Companies (RKT)
Rocket Companies (NYSE:RKT) is a leading mortgage company. It originates mortgages and also operates Rocket Homes which is a real estate agent referral network and home search platform.
Shares lost altitude after a decent start in 2020. The higher interest rate environment has decimated the stock. Mortgage volumes are down as many consumers recoil at the thought of 8% fixed-rate mortgages.
Now, with interest rates starting to fall, traders are positioning themselves for a rebound in mortgage originations. That may well happen. However, I’d caution that this turnaround will likely take longer to occur than bulls are expecting.
As such, rival UWM Holdings (NYSE:UWMC) seems like the safer bet. UWM has held a tighter grip on costs; it is profitable and paying a dividend while Rocket is losing money. A slowing housing market will cause consolidation and retrenchment among the mortgage firms, and Rocket is playing a relatively weak hand going into 2024.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.