Two ETFs For A Housing Rebound

April 9, 2012 David Sterman

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 wont 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 its the funds 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. Its likely to be a lot less volatile as many of the holdings arent 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 hes a bit nervous that the spring season will be underwhelming.

Given that, it wouldnt 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 Lynchs 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.

Though banks will put more homes on the market as they sort out the foreclosure process, economists think the era of too many unsold homes chasing too few buyers has passed.

Indeed, just as supply is dropping, demand should finally start to percolate as 200,000 more Americans find employment every month. We cannot hope to have a robust housing market in the absence of vibrant employment, note analysts at UBS in a recent report.

Cautious Optimism

Companies that build new homes are watching closely as they lay out their own construction plans. Theyve managed to keep a tight lid on supply, with less than six months worth of inventory-down from 12.1 months in 2009-and are expected to slowly ramp up construction activity in coming quarters. Theyve got a lot of catching up to do.

Home builders constructed between 500,000 to 600,000 new homes in each of the past three years, which is the lowest three-year period on record (the data go back to 1959). And its just half the average rate seen during the past 40 years.

Meanwhile, thanks to natural population growth, new household formation averages around one million every year. In a more stable economy, you can expect homebuilders to pour foundations for roughly one million new homes every year just to meet the demands of a growing population.