The housing market has shown signs of finally bottoming out and laying the foundation for an upturn. Though the industry rebound will likely be slow and probably won't reach full speed until the middle of the decade, investors have taken notice by bidding up the shares of homebuilders by a hefty amount year-to-date.
But homebuilders are a variegated lot that focus on different geographies and target audiences, so rather than trying to find the best homebuilding stock to capitalize on the turnaround it might be wiser to invest in housing through an exchange-traded fund that provides broader exposure to the sector without worrying about specific companies.
Two Ways to Play
At first blush, the two ETFs that aim to profit from a housing recovery may appear quite similar. Both the iShares Dow Jones U.S. Home Construction ETF (NYSE: ITB) and SPDR S&P Homebuilders ETF (NYSE: XHB) are liquid vehicles trading more than one million shares a day. Their expense ratios of 0.35%, and 0.47%, respectively, appear reasonable, and both take a broader approach than owning just homebuilders.
Both funds are up more than 20% year-to-date; yet both are well below their all-time highs (roughly 70% for ITB and about 53% for XHB) reached during the peak of the housing bubble. Granted, we likely will never see those highs again, but there is still plenty of upside potential when housing picks up on a consistent basis.
The iShares ETF keeps roughly two-thirds of its assets in home building stocks such as Lennar (NYSE: LEN), D.R. Horton (NYSE: DRI), NVR (NYSE: NVR), Toll Brothers (NYSE: TOL), and PulteHome (NYSE: PHM) each comprising at least 8% of the fund. Roughly one-third of the fund is focused on ancillary plays such as home furnishings, plumbing suppliers and white goods appliance makers.
The SPDR ETF flips that on its head, making these home-focused retailers and suppliers the primary focus, and the home builders a secondary focus. Top holdings include wallboard supplier USG (NYSE: USG), plumbing and cabinet supplier Masco (NYSE: MAS) and fiberglass insulation maker Owens-Corning (NYSE: OC). In fact, M.D.C. Holdings is the largest home builder in the portfolio, and it's the fund's tenth-largest position.
And that sets up an interesting choice: if you think homebuilder stocks will be the strongest beneficiary of improving investor sentiment, then the iShares fund might be the way to go. But if you remain a bit dubious of an imminent upturn and want to preserve capital if the housing sector stumbles anew, then the SPDR fund likely looks more stable, as many of its holdings are exposed to home-building trends across the globe. "It's likely to be a lot less volatile as many of the holdings aren't quite so cyclical," says Michael Souers, who tracks housing sector ETFs for S&P/Capital IQ
Is Housing Really Back?
Existing home sales reached 4.6 million in February (on an adjusted, annualized basis), the highest number in five years. The recent February sales figure (March numbers are due out April 19) may have been boosted by unusually balmy weather in much of the country, and Souers wonders if foot traffic was pulled into winter months. As a result, he says he's "a bit nervous that the spring season will be underwhelming."
Given that, it wouldn't be surprising if home sales pull back in coming months, but the long-term trend appears healthier with each passing quarter.
Declines in housing prices have moderated, but few will call this industry truly healthy until home prices are finally rising. And we might be getting awfully close because the supply of existing homes fell recently to 2.43 million, down 50% from a year ago. Merrill Lynch's Chris Flanagan thinks the era of falling prices is close at hand, though he expects home prices to bounce around the bottom over the next year before they will start rising consistently in early 2013.