Online real estate websites such Zillow, Trulia and Move in the USA, just like Rightmove PLC in the UK, have been on a tear for almost the entire first quarter of 2013. To say that share price appreciation for these stocks has been remarkable would be an understatement, as these stocks have respectively climbed by an average 65% year-to-date. Best performer Zillow rose by 97%, well ahead of its US counterparts Trulia (92%) and Move Inc. (39%) but also Rightmove PLC (35%).
UK investors would be wrong to feel disappointed with Rightmove’s performance vis-a’-vis its US counterparts, because, to be fair, Rightmove PLC has actually risen in the previous years, well ahead of all US real estate websites, with an extraordinary tenfold increase from the low of 2009!
Despite the wide range of share price performance within this small group, it is worth noting that this specific segment of the real estate sector has outperformed the broader indexes by a mile.
In fact, year-to-date, the main US equities indexes are up by about 13,5%-16% and the UK is similarly up by 14%. Furthermore, online websites outperformed US REITs and Homebuilders indexes, respectively up by about 10% and 15%.
What are the drivers for this truly astonishing performance from online real estate service providers and what should investors expect going forward?
Before delving into this question, it is worth remembering that the broad equity markets are currently enjoying a very favourable environment, on the back of unprecedented expansive monetary policies in developed economies across the globe.
Ultra-low interest rates and Quantitative Easing policies provide an extraordinary fuel for real estate investments and the general outlook for housing markets in the USA and the UK seems quite favourable over the next few years.
In the USA, the housing market peaked around April 2007 and troughed in October 2011, after recording an estimated 30% drop (excluding foreclosed homes, the fall is less steep at about -23%) and since then, the market has entered a mild recovery of roughly 7%, albeit with wide differences on a regional basis.
Nonetheless, several issues seem to be hampering a recovery and keeping the housing market from firing on all cylinders.
First and foremost, credit availability remains tough. The majority of transactions taking place involve high quality borrowers or are all cash deals.
Secondly, the regulatory environment is still awaiting final clarifications on several aspects impacting the lending industry and mortgage issuance. Some industry experts also point out that a reform of Government sponsored agencies Fannie Mae and Freddie Mac should be taken into consideration.
With regards to affordability, low interest rates provide a boon for prospective buyers, as mortgage payment/total income ratio remains well below historical averages. Some real estate analysts estimate that it would probably take a 7% mortgage rate to bring average payments back to the long term of 20%, from the current level of 12% (assuming no appreciation of house prices).
Clearly, with mortgage rates below 4%, we are probably still far away from worrying about affordability for most areas of the country, which in return should also bring back a 60-65% home ownership level in the USA.
Meanwhile, several other negative factors such as housing inventory constraints, difficult financing and a relatively high level of negative equity nationwide (about 27% of all mortgage are underwater) seem to indicate that in the next couple of years house prices could be more volatile than in the past, showing great price swings between different geographies and within local areas.
On the other hand in the UK, housing transactions are still at about 50% below the 2007 peak. The downward house price adjustment has led to increasing affordability, despite the sluggish economic recovery. Similar to the USA, market conditions remain supportive for the broad housing markets. Despite the still sluggish domestic economy, low interest rates and the recently announced government Help to Buy initiative should underpin a more robust housing market recovery going forward.
Industry sources seem to indicate tentative signs of recovery and recent RICS surveys seem to suggest that several data points bode well for a more positive outlook for the broader housing market.
Leaving aside for a moment the positive outlook for housing in USA and UK over the medium term, how can we explain such a stellar performance for real estate website stocks?
I am inclined to believe that fundamental drivers such as revenues and website traffic growth have been the catalysts during the first quarter upswing. But these two factors alone would not be enough to justify this upswing. In fact, I also believe that a sanguine investors’ sentiment, high betas and relatively small market capitalizations for these stocks have played their part in the rally.
These internet stocks are still perceived to be high growth names deserving lofty valuation multiples, given that these companies are committed to increasing traffic, improving their brand recognition and adding services, both for desktop and mobile solutions.
Notwithstanding the generally bright outlook for housing and top-line growth for these companies, Zillow’s quarterly results last week have poured cold water on investors’ unbridled enthusiasm. A sense of urgency for a reality check to those who own stocks in this sector or wish to build a position now seems due.
The disappointment in terms of earnings has been shocking to those who were oblivious of valuation metrics and Zillow got hammered 10% in a day on the back of slowing revenue growth and increased advertising expenditures that have had a negative impact on the P&L.
Revenue growth alone is not enough for US website stocks to justify paltry earnings and high double-digit EV (Enterprise Value)/Ebitda (Earning before interest tax depreciation and amortization costs) ratios. Move Inc. is cheaper than market leaders Zillow and Trulia, but its tiny market capitalization (about $430 million) and smaller online market share in my opinion make it a less compelling investment proposition.
On the other hand, Rightmove PLC share price, despite its huge run up to 1900p, seems to have a bit more room to go higher.
Rightmove’s management has been able to expand its Ebitda in the past 5 years at a 25% CAGR. If we look at the relatively basic features in terms of services offered, when compared to its more sophisticated US counterparties, I would be inclined to believe that a broader range of services could support its revenue trajectory in the years to come.
Rightmove PLC is enjoying enviable market dominance, boasting nearly 80% market share of UK property websites (as measured by pages viewed) and often ranks in the top 10 most visited websites in the country.
On the margin, I would also not rule out the possibility that this company could be a take-over candidate for a major real estate company or a global Internet service provider, given the synergies an acquisition could generate.
Although Rightmove PLC is remarkably cheaper than Zillow or Trulia, based on EV/Ebitda estimates at about 10x for 2015, I would still point out that this stock is not recommend for faint-hearted.
Online real estate websites provide a very valuable tool to retail customers and brokers alike, providing powerful databases to all users and making typically fragmented markets more efficient in the context of volatile house prices.
I have few doubts that Zillow and other companies in this industry are likely to benefit from several growth drivers going forward, such as increased web traffic advertising and more value-added services (consulting, relocation services, mortgages, renovation etc…), but their current valuation multiples are demanding.
Typically online real estate stocks also correlate with house-hunting seasonality, when more traffic is generally observed in the first half. As a consequence, near term these stocks may have already peaked.
Housing may provide great opportunities in the medium term, but at this point unless you have a strong risk-taking predisposition, I would stick to the bricks and mortar, rather than punting high growth Internet real estate stocks.
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