Warren Buffett Loves These 3 Real Estate Sectors: Should You Too?

Warren Buffett invests in a multitude of industries through his holding company Berkshire Hathaway (BRK.A -0.61%) (BRK.B -0.68%). From textiles and insurance to manufacturing, utilities, financial services and real estate, Buffett focuses on industries with a proven track record of growth, demand and profitability.

When it comes to real estate, Buffett currently focuses on three sectors of this industry. Does that mean you should too? Let’s take a closer look at the sectors and how investors could benefit from a buy.

1. Brokers: there is one that should overtake Berkshire

Liz Brumer-Smith (eXp World Holdings): HomeServices of America is Berkshire Hathaway’s real estate brokerage firm. Focused primarily on residential home sales, the brokerage has approximately 46,000 realtors in more than 900 brokerage offices in 33 states plus the District of Columbia. If you add HomeServices of America’s franchise network of approximately 360 franchisees, that brings its agent total to 99,000, making it the largest brokerage firm in the world.

Brokerage firms earn revenue from every sale made by their agents. The more agents a brokerage has, the more money it can earn. The residential real estate market has been on fire over the past few years, which has been great for brokerages at all levels. Although sales are now collapsing due to growing worries about a housing market correction, the business model at the base can still manage long-term profitability.

The only real estate brokerage that can even come close to effectively competing with HomeServices of America is eXp World Holdings (EXPI -3.12%). This makes it a potentially fantastic purchase to gain exposure to this profitable sector of the industry. eXp World Holdings is a virtual brokerage, meaning it does not maintain physical offices in cities across the United States like HomeServices of America does. Yet he still managed to build a network of over 84,000 agents in 22 markets around the world (who work remotely from home).

The company is by far the fastest growing brokerage today. Over the past two years, it has grown its agent base by 180% while expanding into 18 new countries. Unsurprisingly, his income skyrocketed. Since the company went public in 2015, its earnings per share (EPS) has increased by 37,000% while its free cash flow has increased by 138,000%. The company also has a major advantage over other brokerages in that it has zero debt.

There are certainly headwinds for the brokerage firm, the most obvious being the downturn in the real estate market which could affect its earnings in the years to come. The company’s stock-sharing incentive program for agents could also have a dilutive effect on stock value if the company does not maintain its stock buyback program. But for the moment, there is no major cause for concern. Its second-quarter revenue was up 42% year-over-year, its gross profit was up 34%, and it repurchased $50 million of stock in the second quarter of 2022. It pays a dividend annual of $0.18 per share which yields 1.33%.

The stock has taken a beating in this year’s tech crash and is trading up around 63% year-to-date, making today’s price an opportune time to enter.

2. Title Insurance: Buy the Big Dog in an Industry Where Berkshire Compete

Mike Price (First American Financial): In addition to residential real estate brokerage, HomeServices of America offers a host of other real estate services, including mortgage origination and banking, property and casualty insurance, home warranties, relocation services, and title insurance. I want to go deeper into this last category: title insurance.

Every home purchased with a mortgage must have title insurance. There is no central database in the United States with all title histories, so purchasing title insurance protects both the owner and the lender in an asset purchase where the seller has no real claim to the title.

Title insurance companies typically do a load of research to trace the title, sometimes decades back, and then offer to insure once they are reasonably sure the seller has the true title. The title company also usually offers closing services to ensure that the deed of trust (or whatever the local term is) is properly filed. This is an important point – if the title search process is done correctly, there should be no risk as the title company can prove that the title is legitimate and has been transferred correctly.

America’s first financial (FAF -0.41%) is the 800-pound gorilla in the title insurance business. According to a recent management presentation, First American has a 23.1% market share in the securities and settlement services industry. Its revenue has increased by 12.4% per year over the past five years and its cash flow has increased further during this period to 17.9% per year. She propelled the real estate bull market to new heights as a business.

The question is, how will this hold up through a potential real estate bear market? Interest rates are rising, prices are starting to fall, and sales are slowing. Fewer home sales mean less revenue for First American.

This slowdown is not the company’s first. The first American did well through the dot-com meltdown, the Great Recession and the pandemic. Company management expects new purchases and refinances in 2022 and 2023 to still be higher than what the company did in 2019 – and any other year after 2007.

Even if the downturn is far worse than management plans, the company can simply sit idly by, invest the revenue it earns from existing bonus payments, and wait for the market to come back. If a downturn forces its competitors to close their doors, it just means more potential new customers.

3. Affordable housing: Berkshire believes in it. Do you?

Kristi Waterworth (LGI fireplaces): Buffett is a big fan of affordable housing. With his acquisition of Clayton Homes in 2003, he demonstrated this by putting his money to work investing in housing for the average Joe. Although Clayton Homes is primarily known for its manufactured homes, it completed approximately 11,000 site-built homes in 12 states in 2021 as Clayton Properties Group.

Like Clayton Properties Group, LGI houses (LGIH 2.46%) focuses on affordable housing, which is a niche in the construction industry that remains woefully underserved.

LGI Homes stands out from the competition and resembles Clayton Properties Group because of its ability to make affordable housing widely available and also profitable. An average LGI Homes property sold for $356,719 in the second quarter, compared to an average of $403,800 for an existing home in the United States in July 2022.

In the second quarter, the number of LGI Homes communities fell to 91.3 (compared to 105 in the second quarter of 2021). But its gross margin on each home sold rose to 32% in the second quarter, from 27% last year. Improved margins give the company a bit more leeway to maintain operations if house prices fall further due to rising interest rates.

Overall, the real estate market continues to suffer from a lack of inventory of existing homes, with only 3.3 months of supply available in July 2022. Economists from the National Association of Realtors consider six months of inventory are a good amount, and the industry hasn’t seen that number in years. Even at 3.3 months, the market is still 45% below that six-month mark. This shortage bodes well for LGI Homes.

Homebuilders – especially builders of affordable housing – are just as important as ever, regardless of what the headlines about rising mortgage rates might imply, and LGI Homes is a quality builder with inventory that can be obtained at a great price right now.

About Mary Moser

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