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Will Rising Home Prices Hurt Housing ETFs in 2018?

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Home sales in the United States dropped more than expected in December as supply of houses fell to a record low. This has increased home prices and caused an aversion to home buying among some first-time buyers.

The National Association of Realtors said on Jan 24 that existing home sales fell 3.6% to a seasonally adjusted annual rate of 5.57 million units in December amid decreases in all four regions.

The November sales clip was also revised down to 5.78 million units, but still the highest level since February 2007. Economists polled by Reuters had forecast home sales falling 2.2% to a 5.70 million-unit rate in December from a previously reported 5.81 million-unit pace in November.

Existing home sales, which make up about 90% of U.S. home sales, increased 1.1% on a year-over-year basis in December. Home sales rose 1.1% to 5.51 million units in 2017, marking the highest level since 2006.

Why Such Decline?

The National Association of Realtors held a persistent shortage of houses at the lower end of the market for the sales decline in December. This happened after three straight months of gains.

With supply crunch in place, the median house price rose 5.8% from a year ago to $246,800 in December. With this, the existing home sales industry saw 70 successive months of year over year price gains. House prices shot up 5.8% in 2017, representing the sixth straight year of rise.

Around 24% of homes in 2017 were “sold for more than their advertised price, with buyers of those properties on average paying $7,000 above asking, according to the real estate firm Zillow.” These figures have been on an uphill ride since 2012.

Are There Any Other Deterrents?

As we all know, housing stocks underperform in a rising rate environment, so it is time to think how these ETFs will behave in 2018 given the impact of the tax reform and a hawkish Federal Reserve.

The monthly average commitment rate was 3.95% in December 2017, still down from 4.20% in the year-ago period, but rates may shoot higher given the trend of rising rates.

Also, homebuilders are expected to lose as the new tax bill has lowered the value of the mortgage interest deduction to $750,000 from $1 million, thereby limiting the purchase of luxury homes (read: Tax Bill: What ETF Investors Need to Know).

Bright Points

In December, J.P. Morgan noted that the housing sector began 2017 trading at 9x 2018E EPS and is now trading at around 11.7x 2019E EPS. This gives cues of "more reasonable, albeit still relatively full valuation (read: Housing ETFs to Buy in 2018).”

J.P. Morgan also believes that on average, homebuilders will experience a 17%  EPS increment from the tax reform in 2018, considering a 25% corporate tax rate across the board. Plus, the research house indicated that both single-family housing starts and new home sales will likely expand around 10% in 2018 (read: Will Tax Reform Help or Hurt Housing ETFs?).

But falling home inventories are turning out to be a key issue in the space. And investors should keep close eye on the housing ETFs in the days to come. SPDR S&P Homebuilders ETF (XHB - Free Report) and iShares U.S. Home Construction ETF (ITB - Free Report) are two main ETFs in the space. One can also consider PowerShares Dynamic Building & Construction Fund (PKB - Free Report) . The funds are up 5.1%, 4.7% and 3.5% in the year-to-date frame (as of Jan 24, 2018).

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