Commercial Construction Is Ready For Take Off

By Aaron Levitt | Updated September 02, 2014 AAA

When it comes to new construction, housing continues to captivate investor’s attention. After all, the sector was one of the main reasons why the economy “popped” and the Great Recession happened in the first place. The sector was hit hard and prices for homebuilder-focused funds- like the SPDR S&P Homebuilders ETF (NYSE:XHB) -fell into the single digits.

The subsequent rebound in homebuilding has been quite swift and has made investors a pretty penny.

The often ignored commercial construction sector is also starting to recover. For investors, the sector could offer a chance to play a housing-like rebound from the ground floor. And if history is any guide, it should provide plenty of similar gains.

Architecture Billings Rising

While housing sector construction has taken off, construction of strip malls, office parks and the like hasn’t been so spectacular. But things could finally be turning around for the commercial construction sector. Key index data is starting to move in a positive direction.

First, more projects have begun to be planned. The American Institute of Architects' (AIA) latest Architecture Billings Index (ABI) continued to rise in February. The measurement reflects the demand for design and contractor services. Last month, the ABI increased to 50.7- up from a 50.4 reading in January, just as January’s reading was an improvement on December's. A measure above 50 indicates an increase in billings.

Secondly, banks have recently begun reporting an increase in the number of commercial mortgages and loans. As they’ve eased credit requirements since the bust, banks and insurance firms have issued more commercial mortgages to property owners. A prime example is New York-based insurer MetLife (NYSE:MET). MET upped lending for commercial properties by 19% last year.

With these two factors- along with continued low interest rates courtesy of the Federal Reserve- the AIA estimates that overall commercial and industrial facilities construction will increase by 10% this year and see slightly higher growth in 2015. Yet many of the stocks associated with the sector haven’t experienced the same sort of hare price gains as their homebuilding twins. That makes them ripe for a portfolio.

Building A Commercial Construction Portfolio

Given the bullish tailwinds propelling the construction sector, investors may want to switch out of homebuilding stocks like Miami's Lennar (NYSE:LEN) and into the providers of commercial construction products and services. A great place to start is the PowerShares Dynamic Building & Construction ETF (NYSE:PKB).

PKB tracks 30 different firms that provide construction and related engineering services for building and remodeling residential, commercial or industrial properties. It also includes some of the major infrastructure related firms. Top holdings include Calhoun, Georgia-based flooring company Mohawk Industries (NYSE:MHK) and North Carolina's home improvement giant Lowe's (NYSE:LOW). Overall, PKB makes a great broad choice to play the entire spectrum of rising construction in the U.S. The fund’s mid- and small-cap tilt helped it produce a 29% return in 2013 and expenses run a small 0.63%.

Atlanta-based home improvement store Home Depot (NYSE:HD) has swelled on the recent bullishness in the housing sector. Yet, its recent Atlanta spin-off HD Supply (NYSE:HDS) maybe the better bet. The firm distributes various supplies needed to build and maintain commercial buildings. The sheer breadth of their product line makes them an ideal play on construction and industrial markets. More importantly, HDS has recently had several quarters of triple-digit earnings growth gains. That could make the firm a better buy than its former parent as well as competitors like Illinois-based industrial supplier W.W. Grainger (NYSE:GWW).

Finally, the material producers could be seeing a boost to their bottom lines as construction activity increases. Beaten down cement plays such as Ireland’s CRH (NYSE:CRH) and Mexico’s CEMEX (NYSE:CX) have recently began reporting better numbers, while North Carolina's aggregate firm Martin Marietta Materials (NYSE:MLM) and Idaho timber company Boise Cascade (NYSE:BCC) have seen expanded industrial demand for their products. All in all, the firms that produce needed construction products should start to see rising profits as ABI’s billings actually turn into breaking ground.

The Bottom Line

While housing construction has taken off, commercial construction is just beginning to see the light of day. That means investors still have time to bet on the sector for long term gains. The previous picks make ideal selections in playing the growth in rising commercial construction.

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