After peaking in late 2006, the American real estate market has been a horrible place to be. Prices have declined more than 50% in certain markets, (Phoenix, Las Vegas, pretty much all of Florida) foreclosures are everywhere, and all sorts of people have decided that paying a mortgage that’s underwater is a sucker’s bet, so they stopped. Housing starts plunged, since the banks had taken so much inventory back, coupled with a lack of demand. Basically nobody buys when the market is going down, which has been going on for years now. So, yeah, the U.S. housing market is pretty bad right now.

As a contrarian investor, I’m naturally interested in U.S. housing at these depressed levels. It seems like everybody is talking about how horrible the market is, even after 5 years of losses. Even yesterday, housing start numbers were down over 23% from last April’s already depressed numbers. Check out this chart of U.S. housing starts since the beginning of the millennium:

 

As you can see, housing starts are down significantly from their highs. They’re even down significantly from more normalized levels of 2000. They’re only a hair above the lowest levels ever recorded in the early part of 2009, when everyone thought the world was going to end.

Is this market going to recover soon? Or are we due for years more of pain? I don’t know the answer of when, but the U.S. housing market will eventually recover. It’ll probably take years, just like any good recovery does. As any good contrarian knows, getting into the market before the recovery starts is the key to some good profits for the patient investor. So how should an investor play a recovery in the U.S. housing market? I have some ideas…

ETFs

There are all sorts of ETFs that an investor can buy that have exposure to the real estate market, each of which has a slightly different angle on it. There’s the Homebuilder’s ETF, which tracks the S&P Homebuilders Select Index. This index includes homebuilders, building supply companies, big box home improvement retailers and mobile home manufacturers. It pays a dividend of just a hair under 2%, which is always nice for a contrarian investor waiting for the market to recover. It may be the best, most diversified way of playing a real estate recovery, except investors may lose out on the enhanced returns by picking individual stocks.

Another ETF that will do well as the economy recovers is the mortgage REIT ETF, which I’ve talked about before on this very sexy blog. This ETF is also exposed to rising interest rates, however it will most undoubtedly have a sympathy rally with the rest of the housing market. An investor is getting paid 8% to wait, a generous yield, plus the potential for a capital gain down the road.

Actually Buy A Rental. Or Several

In around 2008 or so, I actually thought about buying rental property in the U.S. I knew enough to avoid the craziness of Phoenix or Las Vegas, and was looking in Texas, particularly Houston. It has a diversified local economy, lots of universities and reasonable prices that offered solid returns in the 10-15% range.

Of course, being an absentee landlord is hardly a walk in the park. You need to find a good property manager, preferably one that won’t rip you off. Taxes are high in certain areas, and higher for foreigners in other areas. Ultimately, every little issue becomes a little more complicated when a landlord isn’t there.

Other Plays

An interesting way to play a recovery is a company called Stewart Information Services. Stewart provides title insurance and real estate information services to real estate companies. The company is profitable, has a small dividend and is trading at levels far below their real estate boom fueled high. They are sitting on significant debt though, and revenue has declined from the boom years by about 25%.

Or, an investor could buy one of the many regional banks that have all sorts of mortgage debt on their books. You could spend the time to try to identify the cream of the crop, or just buy the SPDR Regional Banks ETF.

There are all sorts of REITs out there as well, but most have had significant movements from their lows. A lot of them are close to levels that they traded at at the peak of the market. So I’d stay away from them.

How Would You Play It?

It seems to me that buying the homebuilders ETF is the best way to play the market, except it isn’t a pure play on the sector, thanks to inclusions like Home Depot. While an improved real estate market will help Home Depot, it’ll help a homebuilder that much more. I like having the diversity of many different names, as well as a dividend to keep me happy until the sector recovers.

Readers, have you thought about trying to invest in U.S. real estate? Any names or strategies you want to share?

Tell everyone, yo!