This article was written by Nick Kalivas, a Senior Equity Product Strategist for Invesco PowerShares Capital Management LLC, a registered investment advisor that sponsors the PowerShares family of exchange-traded funds (ETFs).
In a world where exporters and energy producers have struggled, investors may wish to consider the construction sector for ancillary investment opportunities. Real estate is one area of the US economy showing undisputed strength, and recent data argues for continued expansion, in my view. With so much momentum built up, I expect that it’s going take more than a few small rate hikes by the Federal Reserve to dampen this story.
Consider:
- Real estate research firm Zillow recently reported that rents increased 3.3% nationally during the second quarter.1
- Zillow asserts that the combination of rising rents and low mortgage interest rates has made home affordability as high as it’s ever been.1
- The Dodge Momentum Index of construction contracts has been showing strength and points to healthy levels of construction well into 2016.2
- The Architecture Firms Billing Index has been in the mid-50s, indicating that architecture firms are reporting an increase in activity.3
Let’s consider these trends more closely.
Renting rents are rising, mortgage rates are low
Higher rents are making renting more expensive, which should cause two effects, in my view: First, renters will look to make new home purchases to “save” money and build equity. Second, multifamily housing developers looking to capitalize on high rents could create a greater supply of rental units. The return on capital from high rents means that, in many cases, it makes good sense to build new rental units – many of them targeting high-earning millennials in rejuvenated urban neighborhoods.
At the same time that rents are going up, home ownership is becoming more affordable. According to Zillow:
- Home buyers can expect to pay 15.1% of their income on mortgage payments for a typical US home – down from 21.3% in the years from 1985 to 2000. And Zillow believes that mortgage payments will be affordable even if interest rates rise.1
- Compare this with US renters, who can expect to pay an average of 30.2% of monthly income on rent, according to Zillow – a record high. This is up from 29.5% at this time last year and 24.4% before the real estate bubble.1
- Rental affordability worsened year-over-year in 28 of the 35 largest metropolitan areas.1
Clearly, there are some extraordinarily expensive housing markets in the US. Zillow categorizes Denver, Los Angeles, San Francisco, San Jose, and San Diego as unaffordable for both renters and buyers. But assuming a 6% mortgage rate next year, home buyers can still expect to spend 30% or less of income on mortgage payments in 265 out of 290 metropolitan areas.
Construction spending is on the rise
Construction trends are also on the rise. The Architecture Firms Billing Index was 54.7 in July; any score above 50 indicates an increase in billings.3 As shown in the chart below, the Architecture Firms Billing Index typically comes out roughly a year ahead of the US Census Bureau’s construction spending reports. The strength of the index augurs for positive growth in construction spending into mid-2016. There may be a short-term pause, but conditions are generally favorable, in my view.
In addition, the Dodge Momentum Index tracks US construction activity, and is up 27.7% on a year-over-year basis. Construction starts are expected to increase 9% in 2015 and will reach $612 billion.2
PKB has strong momentum