Housing Sector Recovery Bodes Well for This Forest Products REIT - TheStreet

Real estate investment trusts have gained a considerable amount of momentum since Standard & Poor's said that it was adding a separate real estate sector to the benchmark S&P 500.

It didn't take long for REITs to become a hot commodity, given their propensity for risk mitigation and dividend growth.

For what it is worth, REITs have outpaced the S&P 500 this year. The Dow Jones Equity All REIT Total Return Index is up 13% this year, while the S&P 500 has gained 6.1%.

It is important to note, however, that the recent exposure comes at a price. REITs are more expensive as a result of their increased popularity, so it is harder to find attractive options with growth potential that aren't too pricey.

Although most large-capitalization REITs have seen their prices increase, there are still deals to be had and good ones at that. One REIT, in particular, is still relatively cheap and worth consideration: Potlatch (PCH) - Get Report .

With about 1.6 million acres of forestland in Alabama, Arkansas, Idaho, Minnesota and Mississippi, Potlatch has managed to create a commercially viable REIT while ensuring its long-term sustainability. In a market where most REITs specialize, Potlatch has proven capable of owning land, growing and harvesting trees, and even manufacturing forest products.

The draw of this particular REIT, however, isn't only sustainable harvesting practices, nor is it the land that Potlatch owns in five states. Potlatch also conducts a real estate sales and development business.

Perhaps most importantly, however, is how well Potlatch has positioned itself to take advantage of the housing sector recovery. Dealing in both timber and real estate, Potlatch has become the beneficiary of two surging markets that inherently compliment one another.

The recovery has seen the demand for lumber increase dramatically in less than a year.

"Lumber [futures have] surged more than 50%" since last October, according to Nasdaq. "The rise is mainly a result of increasing demand from the housing market."

Potlatch's business model is capitalizing on diversification in a way that many REITs are unable to. The demand for housing in this market has seen U.S. home construction reach a six-month high as recently as last month.

"Apartment construction in the Northeast fueled a jump in home building in July as the pace of housing starts nationwide reached the strongest pace in six months,: according to Yahoo Finance.

"The rate of overall construction rose 2.1% to a seasonally adjusted annual rate of 1.21 million from 1.19 million in June," the Commerce Department said recently.

That was the highest level since February. The increase in U.S. construction rates may be attributed to the accelerated demand for multi-family apartment buildings, as more people are starting to rent than own.

"The home ownership rate of 62.9% was 0.5 percentage points lower than the second quarter 2015 rate (63.4%) and 0.6 percentage points lower than the rate in the first quarter 2016 (63.5%)," according to the U.S. Census Bureau.

The concept is relatively simple.

Potlatch has seen profits increase from its timber division as a result of the demand for new home construction. The pace of the housing recovery, on the other hand, contributed to better-than-expected earnings from its REIT subsidiary that sells and develops real estate.

As a result, Potlatch's second-quarter earnings surpassed those in the first quarter. Second-quarter operating earnings came in at $5.4 million or 13 cents a share, compared with $200,000 or no earnings per share reported in the first quarter.

Not surprisingly, forecasts are starting to reflect the company's progress.

Although Potlatch's future appears bright, it is worth noting that the second quarter wasn't an aberration but rather more indicative of a three-year trend. In fact, shareholders have seen their dividends in Potlatch increase by as much as 20% in the past three years to 3.87%.

What's more, there is nothing to suggest that dividend growth won't continue for the foreseeable future, as the housing recovery looks to have gained traction, and lumber sales should continue to increase as a result. That is what analysts expect the third-quarter earnings report to show.

Those familiar with the REIT are confident in its earnings potential, so much so that analysts expect Potlatch's third-quarter earnings to increase nearly 34% from a year earlier to 71 cents a share. If that estimate is correct, profits will reach $28.82 million for a price-earnings ratio of 13.70.

Analysts aren't the only ones who are bullish on Potlatch.

"Proceeds from the central Idaho timberlands sale that we announced in April were used to pay $42.6 million of debt and repurchase almost 170,000 common shares at an average price of $35 per share," Chairman and Chief Executive Mike Covey said. "We expect seasonally higher harvest volumes and sawlog prices along with increased lumber shipments and prices to drive strong third-quarter results."

It is hard to deny that Potlatch is sitting pretty, as both timber futures and real estate look more than capable of maintaining their momentum. And the recent strength in the housing sector also bodes well for Potlatch.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.