Why housing?
American housing is hotter than ever. Prices have risen at the fastest pace since 2006, while record low interest rates compel investors to acquire cash flow positive properties. Meanwhile, homeowners are refinancing their homes while others take advantage of newly-acquired home equity by trading up or moving cross country.
All this activity is starting to drive real estate-related equities.
In short, the housing market is once again…well, active.
How to play activity in real estate
Other plays on American housing may not offer a compelling valuation. The whole housing sector as measured by the SPDR S&P Homebuilders (NYSEARCA:XHB) is up 21% year-to-date and 50% over the last year. This kind of surge doesn’t lend itself to bargains.
So where does Mr. Ashton say investors should look to play growth in housing? He says the bargains are in title insurance companies.
Title insurance companies protect the homeowner and seller from any issues in the legal claim to property. The business is very profitable, in part because insurance is virtually unavoidable during a real estate transaction and in part because claims are very rare.
Additionally, the industry offers unique economics:
- There are really only four players in title insurance, which allows for “rational” pricing designed to create profits, not compress margins.
- Title insurance profits grow with an increase in activity (sales and transfers of real estate plus refinances) and the price of real estate (higher prices mean higher premiums).
- Customers are worth thousands of dollars each, ranging from $1,000 in revenue on refinances to $7,800 for commercial real estate transactions.
Insurance stocks worth a look
One of the largest players in the space is First American Financial Corp (NYSE:FAF), which became a pure-play on title insurance and related services after spinning off real estate data services company CoreLogic in 2008.
This spin off has made First American Financial Corp (NYSE:FAF) a true pure-play on real estate transactions. The company reported an excellent quarter in the first quarter of 2013, earning 33 cents per fully diluted share as total revenues were up 19% and agent premiums rose 29%. Growth is largely attributed to a boom in refinances, as American homeowners use HARP to refinance at a lower interest rate.
Like many financial firms, First American Financial Corp (NYSE:FAF) sells at a huge discount to the broad market, at nine times last year’s earnings and eight times forward earnings projections. The company generates virtually all of its earnings in the form of cash. The company doubled its dividend in 2012, and will continue to consider new dividend increases in the future. Meanwhile, the company shops for bolt-on acquisitions to consolidate even more of the title insurance business under its umbrella.
Another large player in title insurance is Fidelity National Financial Inc (NYSE:FNF). The company started as a pure play, but has since diversified into unrelated businesses, using leveraged buyouts to acquire positions in restaurant and car parts companies.
Fidelity National Financial Inc (NYSE:FNF) owns a 55% stake in American Blue Ribbon Holdings, which is best known for owning and operating national restaurant chains O’Charley’s, Max & Erma’s, and Village Inn concepts. It also owns an 87% interest in the parent company for J. Alexander’s and Stoney River Legendary Steaks, as well as a 51% position in Remy International, a designer, manufacturer, and distributor of car parts.
Fidelity National Financial Inc (NYSE:FNF)’s performance is heavily tied to the health of the economy. While it is a diversified business involved in several product lines (granted, insurance remains the biggest profit-driver), all of its businesses are highly cyclical. Investors who want to play American housing would be better suited with First American Financial, since Fidelity National Financial Inc (NYSE:FNF)’s capital allocation is suspect; it would appear that the company plans to invest substantially all title insurance profits in unrelated businesses. Sadly, in the first quarter of 2013, Fidelity National Financial Inc (NYSE:FNF)’s car parts and restaurant businesses generated pre-tax losses.
The bottom line
There is no better moat than selling a product people must purchase if they want to buy, sell, or refinance real estate. The market for title insurance will be around in 2050 just as it exists in 2013. The predictability and sustainability of this business model makes this firm an excellent play on housing.
First American Financial Corp (NYSE:FAF) is the best, biggest, and only pure-play in the space with the goal of growing market share within the rapidly consolidating industry of title insurance.
The article Earn a “Royalty” on Exploding Home Sales originally appeared on Fool.com and is written by Jordan Wathen.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
