Home builders ripe for deals: Strategist

By some indications, the real estate market is in full recovery mode. Existing home sales for May came in at 5.35 million units on an annualized basis versus expectations of 5.26 million. But stock investors may be more interested in the new home sales data that releases on Tuesday.

The demand for new homes powered KB Home (KBH) to deliver strong Q2 earnings. Investors will see if the trend continues when fellow homebuilder Lennar (LEN) reports on Wednesday. It’s a reversal from the past couple years when homebuilder stocks (XHB) consistently underperformed the S&P 500 (^GSPC) in the second quarter.

Homebuilders stocks have been also range-bound for the past few months. Rising rates don't bode well for housing either. But Paul Schatz, chief unvestment officer at Heritage Capital, said he sees tailwinds boosting the homebuilding sector. “The big one is they just had their real first M&A deal in a really long time and that sector is so ripe for consolidation,” Schatz said referring to Standard Pacific (SPF) merging with Ryland Group (RYL) for $5.2 billion, which would create the country’s fourth-largest home builder.

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"Just M&A alone could springboard a lot of these stocks higher," the money manager said, adding that dealmaking in the sector is just kicking off. "Some of the big ones could clearly be the acquirers."

Schatz recommends to “play the whole sector through either the etfs XHB or ITB rather than analyze through” specific stock names. He prefers the builders over REITs.

“Tailwinds for commercial REITs have long expired which is a constant decrease in long term interest rates," he noted. “Commercial REITs are more of an interest rate, dividend, almost a defensive play,” as a reasons for them taking a backseat to the homebuilders.

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