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Homebuilder ETFs: Can the Rally Continue?

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It is pretty clear to most investors that one of the major reasons for the weak economy over the past few years was the housing crisis. Sluggish economic conditions, low consumer confidence, rising jobless rate and tightened mortgage-lending standards further exacerbated the condition of this key industry.

Having survived the hazardous years of 2007-2009, the housing market is once again on the path of recovery. Indeed, 2012 proved to be a strong year for the market with significant upside noticed in new home sales volume and other key industry statistics (Two Sector ETFs to Buy in 2013).

It seems that mortgage interest rates hovering near record lows along with somewhat higher rentals have turned the tide for the sector thereby making homes more affordable. Also, a higher employment level and rising consumer confidence in the market have undoubtedly made the path to recovery smoother for the sector.

It should also be noted that the inventory of foreclosed homes and short sales are declining, thus stabilizing the prices of new homes. Additionally, many buyers are selecting larger and more upscale homes with energy-efficient features, which are increasing the average sales prices (Housing ETFs Rally on Solid Data).

Moreover, orders for new homes, backlogs, and homes to be delivered are steadily increasing and with market demand gaining momentum, home prices appear to be on the rise.

If that wasn’t enough, investors are also seeing greater confidence out of the homebuilder sentiment index. The benchmark has been surging and is back to pre-recession levels, while estimates of sales sentiment are also positive (Is XHB a Better Housing ETF Play?).

Based on this information and the shifting perception of the housing market, it appears as though the residential construction sector can continue its recovery with tremendous upside potential going forward.

In fact, homebuilder ETFs have been one of the top performing sectors in 2012 attributable to improving housing and job data. The ETFs continued to maintain its uptrend in 2013 trying to break the highest levels witnesses before subprime crisis (Best Construction ETF to Ride the Housing Upswing?).

Below we are highlighting two ETFs tracking the homebuilder segment, either of which could make for interesting plays if this trend continues:

iShares Dow Jones US Home Construction (ITB)

Investors looking to capitalize on 2012’s best performing sector should invest in ETFs that have heavy exposure to the residential real estate market. And for a direct exposure to U.S. homebuilding companies, ITB represents an excellent option (Top Zacks Ranked Construction ETF- ITB).

ITB offers a pure play into the sector as evidenced by its allocation of 64.79% of its asset base of $2 billion to home construction companies. Among building materials, home improvement and furnishing, the allocation is limited to 40%.

The fund also offers exposure to 29 companies in which established homebuilders like Pulte Group, DR Horton Inc and Lennar Corp make up the top line of the fund.

All of these companies could be poised to deliver strong gains going forward, thereby providing a boost to the performance of the ETF. The fund charges an expense ratio of 47 basis points, making it an average cost choice.

The fund ended 2012 on a high note recording a gain of 78.87% and also started the year with a bang delivering a gain of 10.6%.

SPDR S&P Homebuilders ETF (XHB)

XHB appears to be rich in an asset base of $2.5 billion and offers liquidity as revealed by its trading volume of more than 4 million shares a day. The fund charges a fee of 35 basis points a year (Top Ranked Homebuilder ETF in Focus: XHB).

The fund’s asset base is spread across 36 securities. However, it should be noted that for investors looking for a direct exposure to residential real estate companies, XHB is probably not a good fit.

XHB has just 29.2% of its asset base in homebuilding while the rest is spread across building products, home furnishing retail, home improvement retail and household appliances.

Apart from the core housing market, there are other sectors closely allied to it. The positive sentiment for housing has also influenced these related sectors as evidenced by the performance of XHB in 2012.

The fund does well to minimize company-specific risk thanks to its equal weighting. It invests 36.6% of its asset base in the top ten holdings. Among individual holdings, Mohawk Industries, Tempur Pedic and D R Horton Inc. form the top line of the fund with respective shares of 3.82%, 3.81%, and 3.75%.

The fund delivered a return of 9.1% in the year-to-date period while the 2012 gain was a whopping 57.15% -- a testimony to the housing market recovery.

Bottom Line

Both of these ETFs currently are ranked two or better (ITB is a 1 and XHB is a 2), so we think they are buys in this environment. Yes, they have run up quite a bit in the past few months, but these solid trends look likely to continue, suggesting that more gains could be ahead for these two ETFs.

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