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Here's Why Homebuilding ETFs Are Soaring

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The U.S. housing market has been on a tear this year. The success is primarily attributable to a decline in mortgage rates, slower home price growth and a slew of upbeat data. Notably, the Dow Jones U.S. Select Home Construction Index, one of the most widely followed gauges of homebuilder and home improvement equities, has surged nearly 41.6% this year compared with the 20% gain of the Dow Jones Index.

Here we discuss some valid reasons for the sector’s outperformance. These factors are likely to fuel the rally for the remaining year as well:

Low Mortgage Rates

Mortgage rates have been on a declining trend this year, hitting a three-year low in recent weeks. Per mortgage-finance company Freddie Mac, average rates for a 30-year fixed mortgage have remained below 3.6% for four straight weeks, marking the first such case since the fourth quarter of 2016. This is down from a high of around 4.5% at the start of this year (read: Homebuilder, REIT ETFs Booming on Falling Mortgage Rates).

The decline came on the heels of a slowdown in global growth and the recession fears sparked by the bond market. The trend is likely to persist for the remainder year given that the Fed cut interest rates twice this year since the financial crisis — one in July and the other at the latest FOMC meeting.  

The low interest rate environment has led to a strong wave of optimism for homebuilders, pushing stocks higher. This is because lower rates have made home purchases and refinancing mortgages more affordable. This, in turn, boosts activity in the market and lifts homebuilder stocks.

Slow Home Price Growth

U.S. home prices rose at the slowest rate in nearly seven years in June. The S&P CoreLogic Case-Shiller national home price index posted a 3.1% year-over-year increase in June, down from 3.3% in May. This represents the 15th straight month of decline. The 10-City Composite annual increase came in at 1.8%, down from 2.2% in May while the 20-City Composite inched up 2.1% annually, down from 2.4% in the previous month (read: Housing ETFs & Stocks to Buy on Likely September Rate Cut).

Upbeat Data

The latest favorable data shows that U.S. home construction soared to more than a 12-year high in August. U.S. housing starts jumped 12.3% to a seasonally adjusted annual rate of 1.364 million units, the highest level since June 2007. Uptick in construction activity was broad-based with a big 30.9% ascent in apartments and condominiums, a 32.8% increase in multi-family houses and a 4.4% rise in single-family houses. This suggests that lower mortgage rates were finally providing an impetus to the struggling housing market.

New applications for building permits, a construction bellwether for the coming months, climbed 7.7% to an annual rate of 1.419 million – the level last seen in 2007. Further, confidence among the nation’s homebuilders skyrocketed this year as indicated by the National Association of Home Builders/Wells Fargo sentiment index.

Further, solid economic fundamentals are fueling growth in the sector. For instance, the unemployment rate is low, housing affordability is improving, homebuyer demand is rising, refinancing is booming, home price growth is stable and consumer confidence at a multi-year high (read: ETFs to Buy as Americans' Confidence Nears 19-Year High).

How to Play

Given this optimistic scenario, investors seeking to capitalize the solid trend in the homebuilder space could look at the three ETFs that make for a more compelling choice rather than a single stock. These products erase company-specific risks and provide a higher level of diversification while reducing volatility. All these have a Zacks ETF Rank #3 (Hold) with a High risk outlook.

iShares U.S. Home Construction ETF (ITB - Free Report)

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 $1.2 billion, it holds a basket of 46 stocks with heavy concentration on the top two firms. The product charges 42 bps in annual fees and trades in heavy volume of around 2.3 million shares a day on average. It has gained 42% so far this year (see: all the Materials ETFs here).

SPDR S&P Homebuilders ETF XHB

The most popular choice in the homebuilding space, XHB, follows the S&P Homebuilders Select Industry Index. The fund holds about 35 securities in its basket with equal-weighted exposure of around 5%. It has AUM of $668.5 million and trades in volume of almost 2.3 million shares. The fund charges 35 bps in annual fees and is up 34.1% in the year-to-date time frame.

Invesco Dynamic Building & Construction ETF PKB

This fund follows the Dynamic Building & Construction Intellidex Index, holding well-diversified 30 stocks in its basket with each accounting less than 5.2% share. It has amassed assets worth $113.7 million and sees lower volume of roughly 15,000 shares per day on average. Expense ratio comes in at 0.58%. PKB is up 37% so far this year (read: ETFs to Grab as US Existing Home Sales Hit a 5-Month High).

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