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Are Homebuilder ETFs in for Tough Times?

Sweta Jaiswal, FRM

The latest round of disappointing data on housing starts, building permits, new home sales and existing home sales shows that all is not well in the U.S. housing market. Moreover, Leading Indicator of Remodeling Activity (LIRA) developed by Harvard University’s Joint Center for Housing Studies has forecasted a decline in expenditures on renovation and maintenance in 2020. Let’s see whether the U.S. housing market is headed for a slowdown (read: Global Real Estate ETFs Scaling Higher: Here's Why).

Rising House Prices

Of late, a surge in home prices has been observed which is wiping out the benefits of low mortgage rates and thus, affecting sales. Continuous supply shortages can be cited as one of the primary reasons for the soaring home prices. In fact, seeing a rise in price for the 91st straight month, the median existing house price rose 5.9% year over year to $272,100 in September.

Low Inventories Build Pressure

Builders continue to bear the brunt of rising development and construction costs apart from trade woes. They are grappling with regulatory burdens, deficit of lots and lack of skilled labor. These are affecting supply, which in turn, is disturbing the reasonable pricing of homes. In fact, there was a 2.7% year-over-year decline in inventory levels to 1.83 million homes in September. Notably, inventory levels dropped for the fourth straight month.

Mortgage Rates

Per the Mortgage Bankers Association, an uptick in the average 30-year fixed-mortgage rates from 3.92% to 4.02% was observed in the week ending Oct 18. The rise in borrowing costs resulted in around a 12% fall in mortgage and a 17% drop in refinance applications.

Weak US Housing Data

The latest data on U.S. housing starts reflected a decline of 9.4% in September to a seasonally adjusted annual rate of 1.256 million units. The figure lags  analysts’ expectations of 1.320 million units, per a Reuters’ poll. The decline was largely due to weak construction in the multi-family housing segment. Moreover, NAR’s data showed a 2.2% drop in existing homes sales to a seasonally adjusted annual rate of 5.38 million units in September. This compares with an upwardly revised 5.50 million units in August. It also disappoints when compared with Reuters economists’ forecast of a 0.7% decline to 5.45 million units. Adding to the gloom, sales of new homes dropped 0.7% in September to an annualized rate of 701,000, per the Census Bureau and the Department of Housing and Urban Development.

Is There Any Silver Lining?

The Fed has cut interest rates for the second time at the FOMC meeting in September. When interest rate drops, mortgage rates decline, making real estate or refinancing mortgages more affordable. This, in turn, leads to higher home sales. Moreover, the market is expecting another Fed rate cut soon, which might provide some strength to the U.S. housing market. In conjunction with attractive mortgage rates, low unemployment levels and rising wages can lead to a favorable environment for the U.S. housing market.

Industry experts also believe that Harvard’s LIRA index doesn’t continuously adjust itself for changes in sentiment and mortgage rate. Meanwhile, the U.S. homebuilders sentiment data for October has hit the highest level since February 2018. Per the monthly National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI), builder confidence rose to 71 in October compared with 68 in September, 67 in August and 68 a year ago.

Homebuilder ETFs in Focus

Against the backdrop, let’s take a look at some homebuilder ETFs.

iShares U.S. Home Construction ETF ITB — up 33.5% year to date

This fund provides exposure to U.S. companies that manufacture residential homes by tracking the Dow Jones U.S. Select Home Construction Index. With AUM of $1.40 billion, it holds a basket of 45 stocks, heavily focused on the top two firms. The product charges 42 bps in annual fees and trades in a hefty volume of around 2.1 million shares a day on average. It has a Zacks ETF Rank #3 (Hold) with a High risk outlook (read: Top-Ranked Sector ETFs to Buy for Q4).

SPDR S&P Homebuilders ETF XHB — up 25%

A popular choice in the homebuilding space, XHB, follows the S&P Homebuilders Select Industry Index. The fund holds about 35 securities in its basket. It has AUM of $809.5 million and trades in average volume of around 2 million shares a day. The fund charges 35 bps in annual fees and has a Zacks ETF Rank of 3 with a High risk outlook (see: all the Materials ETFs here).

Invesco Dynamic Building & Construction ETF PKB — up 29.2%

This fund follows the Dynamic Building & Construction Intellidex Index, holding well-diversified 30 stocks in its basket, with each accounting for less than a 5.4% share. It has amassed assets worth $117.4 million and sees lower volume of around 15,000 shares per day on average. Expense ratio comes in at 0.60%. It is a Zacks #3 Ranked ETF with a High risk outlook (read: An ETF Area That Excelled in September).

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Invesco Dynamic Building & Construction ETF (PKB): ETF Research Reports
 
SPDR S&P Homebuilders ETF (XHB): ETF Research Reports
 
iShares U.S. Home Construction ETF (ITB): ETF Research Reports
 
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