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What Lies Ahead for Housing ETFs?

Zacks Equity Research
Mutual Fund Report for PGOFX

The U.S. housing/homebuilding outlook remains upbeat for the balance of 2017 and 2018 courtesy of historically low mortgage rates, solid economic growth and tight inventory. Consistent job growth along with seemingly high homebuilders’ confidence is adding to the momentum.

What Numbers Have to Say

After few months of weak show, existing as well as new home sales regained its charm, surging 0.7% and 18.9% month over month in September 2017, respectively. In fact, sales of new U.S. single-family homes hit the highest level in nearly 10 years after reporting a slump in recent months. Sales soared 17% on a year-over-year basis in September, per the recently released report by the Commerce Department.

Again, U.S. homebuilders are feeling optimistic despite the recent slowdown in new home sales and the risk of rising labor and materials costs following hurricanes Harvey and Irma. The National Association of Home Builders/Wells Fargo builder sentiment index released last month rose four points to 68 in October, marking the highest reading since May.

Hang-Ups

Earlier this year, the homebuilding industry saw the fastest quarterly home sales in a decade and lent some much-needed support to the economy. The solid sales pace was especially appreciable considering higher prices and mortgage rates.

That said, a tight labor market, limited land availability, higher material costs and a constrained mortgage environment are restricting homebuilders to respond to growing demand. Despite concerns over chances of a series of interest rate hikes by the Federal Reserve, optimism surrounding the housing market remains unruffled. Again, with demand outstripping supply, house prices remain elevated, thereby threatening affordability.

The median existing-home price for all housing types in September was $245,100, up 4.2% from September 2016. September's price increase marks the 67th straight month of year-over-year gains. The median sale price was $319,700 for new homes compared with $314,700 in the year-ago period.

Although homebuilders acknowledge the rise in labor shortage and land/labor cost, they in general expect the housing market to continue to recover this year in tandem with steady economic growth.

Per the National Association of Realtors’ recently released report, existing-home sales (which account for the bulk of purchases)will finish at a pace of 5.47 million in 2017. This is expected to be the best since 2006 (6.47 million), but only shows a 0.4% increase from 2016 (5.45 million). In 2018, sales are expected to grow 3.7% to 5.67 million. The median existing-home price is expected to rise around 5.5% both for this year and the next.

ETFs to Tap the Sector

We take a look at three construction ETFs that are poised to gain from the upswing in the housing market. (See all industrials ETFs here)

SPDR S&P Homebuilders ETF (XHB)

The fund employs a replication strategy in seeking to track the performance of the S&P Homebuilders Select Industry Index, which is an equal-weighted index of the homebuilding segment of a U.S. total market composite index. The fund has an expense ratio – an annual fee – of 0.35%.

The top three industries are Homebuilding (37.2%), Building Products (27.5%) and Home-furnishing (9.6%). The top three holdings are D.R. Horton Inc. (5.5%), PulteGroup Inc. (5.2%) and Lennar Corporation Class A (4.9%). This fund holds 36 stocks with about 46.8% invested in the top 10 holdings.

iShares U.S. Home Construction ETF (ITB)

ITB tracks the Dow Jones U.S. Select Home Construction Index, which measures the performance of the U.S. home construction sector.

The top three holdings are D.R. Horton Inc. (13.3%), Lennar Corp. (9.9%) and NVR Inc. (9.7%). The fund is heavily exposed to the Homebuilding sector (68.4%), followed by Building Products (13.8%) and Home Improvement Retail (7.9%).

This fund holds 47 securities in its basket and has an expense ratio of 0.43%.

PowerShares Dynamic Building & Construction Fund (PKB)

PKB seeks to match the performance of Dynamic Building & Construction IntellidexSM Index, which is composed of U.S. building and construction companies. The top three sector allocations are Consumer Discretionary (47.9%), Industrials (33.2%) and Materials (13.9%). Yet, the fund is more expensive than many other options in the space, charging 63 basis points in annual fees.

Among the 30 stocks in the basket, D.R. Horton, PulteGroup and NVR, hold the top spots with 5.7%, 5.4% and 5.3%, respectively, of total net assets. 

To Sum Up

Investors’ sentiments could be dampened by the possibility of an interest rate hike. Also, skilled labor shortage is a cause for concern as demand continues to rise. Rising land and labor costs too are restricting margins as these limit homebuilders’ pricing power.

However, there are plenty of reasons to be optimistic about the broader housing sector over both the short and the long terms. In this context, the above-mentioned ETFs might be sound bets to play the sector.

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SPDR-SP HOMEBLD (XHB): ETF Research Reports
 
ISHARS-US HO CO (ITB): ETF Research Reports
 
PWRSH-DYN BLDG (PKB): ETF Research Reports
 
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