Stock Quotes in this Article: AVB, BBBY, DHI, HD, LOW, TOL

 MINNEAPOLIS (Stockpickr) -- With flashbacks of 2008 still fresh in most people’s memories, housing is one investment that many Americans have been afraid of lately. That’s understandable anxiety -- leading up to the peak in real estate, many consumers believed that housing prices were immune to drops. But in the months that followed, prices in the fastest-growing regions halved in some cases.

Even investors who didn’t make outsized bets on housing were shaken by the experience. After all, the drop in housing set off the chain reaction that led the U.S. economy into a prolonged recession that we’re still trying to shake off. Frankly, things haven’t gotten much better in 2011. So why would anyone want to invest in housing?

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    For starters, there have been some prominent indications that housing may finally be on the upswing. Key metrics such as housing starts and existing home sales appear to have found their respective bottoms in 2009 and 2010, and Wall Street has been materially underestimating housing numbers for much of this year. At the same time, record low mortgage rates have spiked the Homebuyer Affordability Index, a measure of an average American family’s ability to purchase a home.

    In fact, the index is registering near an all-time high at 183.70.

    Coupled with the large, public bets being made on housing by prominent names such as John Paulson, a reasonable case for housing is starting to shine through for retail investors. The biggest challenge is what to buy to get housing exposure.

    Not all housing stocks are created equal. Today, we’ll take a look at five housing names that actually make sense in this market.

     

    Toll Brothers

    Of all the ways to get housing exposure, homebuilders are the scariest. These stocks’ fortunes are invariably tied to the ebb and flow of the real estate market, as evidenced by the massive devaluations that the industry suffered in the wake of 2008. But that outsized exposure to real estate prices is exactly why homebuilders are the best way to get portfolio exposure to housing right now.
    Toll Brothers (TOL) bills itself as “America’s Luxury Homebuilder,” and by and large, the firm lives up to that title. With an average cost of $570,000, Toll Brothers’ homes cost more than twice as much as the national average cost for a new home in 2010. But that’s exactly why this firm is so appealing.

    Because Toll Brothers has embraced the niche business of building homes for upper-income consumers, it’s been diversified away from the challenges that have stymied more traditional homebuilders. That’s not to say that Toll Brothers is without challenges of its own; after all, high-end homes have been equally challenged in recent years. Even so, the demographic difference could mean that Toll recovers first -- especially as high earnings are more willing to move to find career opportunities in this market.

    A relatively modest debt load and flirtations with profitability in the latest quarter certainly give this stock some extra staying power.

    D.R. Horton

    A more mainstream alternative is D.R. Horton (DHI), the country’s biggest homebuilder. Horton’s average home price weighs in at approximately $206,000 -- less than half the cost of Toll Brothers’ homes, and more in line with the national average. This firm was an aggressive achiever during the height of the housing bubble, and consequently was one of the hardest-hit in the years that followed. Most of those issues have since been resolved.

    Horton hunkered down after 2008, opting to focus its efforts on shoring up its operational costs instead of spending excessive efforts on building and selling houses. While that was a painful decision for investors to stomach, it was the right one, and this stock is looking much more attractive today as a result.

    One of the biggest benefits of both Horton and Toll is the fact that these stocks have already struggled through substantial write-offs to their balance sheets -- it’s likely that accountants overcompensated for the inflated home values that these stocks were based on. As a result, they could see massive returns on capital as the housing market starts to warm up.

    Horton’s balance sheet is strikingly similar to that of Toll Brothers. Ample cash and a relatively small debt load should help these stocks hold onto their inventory as they wait for a more meaningful rebound in real estate prices.

    Horton shows up on a recent list of 10 Bargain Stocks Under $10.

    Lowe’s

    Home improvement retailer Lowe’s (LOW) is the No. 2 player in the duopoly it shares with Home Depot (HD). Even so, investors shouldn’t ignore this stock just because it’s got a smaller footprint than its orange competitor.

    In the last several years, Lowe’s stood out as the stronger name, not willing to sacrifice balance sheet health for growth opportunities. That paid off in 2008, when Home Depot faced a restructuring to save itself from serious financial trouble -- Lowe’s wasn’t forced to take such drastic action.

    But the firm’s exposure to the housing market does make it attractive right now. Initially, investors were concerned that lower housing prices would mean dramatically lower sales for Lowe’s, but that argument never actually played out. Instead, consumers spent money on do-it-yourself upgrades and repairs rather than less accessible new homes and costly contractors. That strength has helped the firm push back above its pre-recession revenue numbers in its most recent fiscal year.

    Private-label products are one of the most attractive growth avenues for Lowe’s right now. Many of the firm’s offerings are already commoditized, and throwing its own products in the mix is likely to contribute quickly to margins. At the same time, innovative offerings such as the new MyLowe’s service is likely to increase customer stickiness in a retail business where loyalty means everything.

    While Lowe’s isn’t as directly related to the housing market as the homebuilders, that may be reason enough to pick it for housing exposure.

    Lowe's one of the highest-yielding retail stocks, shows up on a recent list of Large-Cap Stocks With Room to Grow Dividends.

    Bed Bath & Beyond

    A similar argument works with Bed Bath & Beyond (BBBY), the $15 billion home furnishings retailer that’s best-known for its nearly 1,000 namesake stores. As with Lowe’s investors had been worried that decreased home prices would trickle down to Bed Bath & Beyond’s business, but that argument really never played out. The firm actually saw significant incremental growth numbers throughout the recession, and shares have rallied more than 24% thus far in 2011.

    That momentum makes this name particularly attractive right now.

    Strong merchandising skills are one of the biggest reasons why Bed Bath & Beyond has seen so much success in this market. By focusing on unique, desirable products, it’s able to attract a bigger base into its stores and ratchet up its selling opportunities. A combination of those interesting products and less discretionary offerings (necessities like silverware and bath mats) has fueled a lot of the firm’s sales growth.

    A spotless balance sheet hasn’t hurt either. Unlike most peers, Bed Bath & Beyond has historically opted to fuel its expansion through cash on hand, not debt. As a result, the firm has greatly expanded its geographic footprint in recent years while maintaining zero debt. That lack of leverage means that investors don’t need to worry about liquidity issues if decreased demand does trickle down to BBBY’s top line.

    I also featured Bed Bath & Beyond as one of last week's Rocket Stocks to buy, and it's one of the top holdings at ken Heebner's Capital Growth Management.

    AvalonBay Communities

    It may seem strange to talk about housing exposure without mentioning real estate investment trusts (REITs) up until this point, but it’s been by design. Despite their name, most REITs are terrible ways to get exposure to the real estate market -- nearly all of them engage in long-term, triple-net leases that limit the amount of leasing they have to undertake and insulate them from the ebb and flow of real estate. But there are a couple of exceptions to that rule.

    While most commercial REITs are effectively income-generation tools rather than real estate vehicles, tenant protection laws make residential REITs a more direct way to get exposure to housing. One of the most attractive is AvalonBay Communities (AVB), a $12 billion trust that owns 173 apartment communities in 10 states.

    AvalonBay’s communities are generally newer than the average, and they’re located in geographically attractive areas that are more resilient to recessionary headwinds. Housing prices and apartment rentals aren’t mutually exclusive, especially if the apparent upswing in real estate is slow to take shape. Both could benefit -- particularly because of AvalonBay’s exposure to the luxury end of the apartment spectrum.

    Right now, this REIT pays out a 2.68% yield. Keep in mind, though, that income generation and exposure to housing are tradeoffs -- while AVB’s dividend is a nice bonus, income investors should stick with higher-yielding commercial REITs right now.

    Like Bed Bath & Beyond, AvalonBay is one of Ken Heebner's top holdings.

    To see these stocks in action, check out the Housing Stocks portfolio on Stockpickr.

     

    -- Written by Jonas Elmerraji in Baltimore.

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    At the time of publication, author had no positions in stocks mentioned.

    Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.