The housing market may have hit bottom—so what’s the ETF play on rising home prices?
If you saw the Barron’s cover this week, then you know what I’m talking about. According to the article, home prices are on the rise, and this time it’s not due to temporary tax cuts, as we saw between 2009 and 2010.
As an example, the S&P/Case-Shiller Composite 20-City Index has shown a 4.1 percent increase in home prices since December.
Meanwhile, the National Association of Realtors’ chief economist Lawrence Yun said he expects the “current forecast for median existing home prices to rise from 4.5 to 5 percent this year and about 5 percent in 2013, which is somewhat stronger than historic norms because of the inventory shortfall.”
The inventory shortfall he’s talking about is the direct effect of real estate purchases by investment buyers, who often turn such properties into rentals. Investor purchases accounted for 27 percent of all sales in 2011, up 10 percent from 2010. What’s more, half of all recent investment home sales were distressed homes.
Distressed homes, such as those in foreclosure, are sold on the market at a discount—a double-edged sword for any regular homebuyer, since homes bought at discount lower property values in entire neighborhoods.
Accompanying the decrease in supply has been an increase in demand, and analysts point to a shift in homebuyer mentality.
Not so long ago, people were waiting to buy until after prices fell lower. However, now that prices seem to be picking up, many don’t want to miss the opportunity of owning their first home or upgrading, particularly because interest rates are at an all-time low.
If you aren’t buying property, you can still tap into the rising home prices with a carefully chosen ETF.
Currently, there are 14 U.S. real estate ETFs on the market. The available funds have a broad range of expense ratios and methods of accessing the sector, so choosing the right ETF is crucial.
REITs, as a rule, come in all shapes and sizes. Thomson Reuters classified REITs into four groups: diversified, commercial, residential and specialized.
Unfortunately, most of the ETFs currently on the market invest 50 percent or more in commercial REITs; that is, companies specializing in office buildings and retail malls.
Still, there are some that have a bit less commercial property. For example, the iShares FTSE NAREIT Retail Capped (NYSEArca: REZ) offers the most exposure to residential REITs, with about 50 percent of its portfolio dedicated to such companies.
However, the other half of REZ’s portfolio is dedicated to specialized REITs, mostly in the health care and self-storage subindustries.
Funds that have about 15-20 percent invested in residential REITs include:
- The iShares Cohen & Steers Realty Majors Index Fund (NYSEArca: ICF)
- The iShares Dow Jones U.S. Real Estate Index Fund (NYSEArca: IYR)
- The SPDR Dow Jones REIT ETF (NYSEArca: RWR)
- The Vanguard REIT ETF (NYSEArca: VNQ)
- The First Trust S&P REIT Index Fund (NYSEArca: FRI)
- The PowerShares Active U.S. Real Estate Fund (NYSEArca: PSR)
- The Guggenheim Wilshire US REIT ETF (NYSEArca: WREI)
- The iShares FTSE NAREIT Real Estate 50 Index Fund (NYSEArca: FTY)
- The Schwab U.S. REIT ETF (NYSEArca: SCHH)
Meanwhile, the IQ US Real Estate Small Cap (NYSEArca: ROOF) and the PowerShares KBW Premium Yield Equity REIT (NYSEArca: KBWY) also invest in residential REITs, with exposure at about 9 percent and 3 percent, respectively.
Two funds that completely lack residential REITs entirely are the iShares FTSE NAREIT Industrial/Office Capped Index Fund (NYSEArca: FNIO) and the iShares FTSE NAREIT Retail Capped Index Fund (NYSEArca: RTL).
Both FNIO and RTL invest in commercial REITs, one with a focus on office buildings and the other on retail malls and shopping centers.
I should also note that PSR is actively managed, and although it currently holds only 20 percent in residential REITs, it can increase this position going forward.
Other Ways To Access Real Estate
Those who aren’t satisfied with these choices can choose alternative ways of benefiting from the recovering housing market, such as investing in funds that track homebuilders.
Homebuilders funds such as the iShares Dow Jones U.S. Home Construction (NYSEArca: ITB) and the SPDR S&P Homebuilders ETF (NYSEArca: XHB) have been doing particularly well recently. ITB is the top-returning ETF of 2012 so far, returning 58.57 percent, with XHB at 43.66 percent.
To put those figures into perspective, the two funds are outperforming the SPDR S&P 500 ETF (NYSEArca: SPY) by 42 percentage points and 28 percentage points, respectively.
Both ETFs reach beyond the narrow definition of homebuilders. Although ITB’s portfolio remains anchored in homebuilders, at 68 percent of total holdings, it expands into home furnishings as well as home-improvement retailers—subindustries that will surely benefit from a recovering housing market.
XHB is an equal-weighted option that invests less than 30 percent in homebuilders. The fund instead focuses on companies that specialize in appliances and housewares, holding well-known retail names such as Pier 1 Imports and Williams Sonoma.
Both ETFs hold Toll Brothers and NVR, two of the five companies that Forbes targeted as promising in a real estate rebound.
A third option exists for those who are still looking: mortgage REITs, broadly defined as companies that invest and own property mortgages. The three options available to U.S. investors are the SPDR S&P Mortgage Finance ETF (NYSEArca: KME), the Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) and the iShares FTSE NAREIT Mortgage Plus Capped Index Fund (NYSEArca: REM).
REM invests in U.S. residential and commercial mortgage REITs, while MORT invests in U.S. and non-U.S. companies that derive at least 50 percent of their revenues from mortgage-related activities. That gives it wiggle room to venture outside the mortgage REIT space.
Despite their differences in methodology, MORT’s and REM’s portfolios are similar in size and type: Both hold 25-30 stocks and invest over 30 percent of assets in Annaly Capital Management and American Capital Agency.
Compared with MORT and REM, State Street’s KME looks like an oddball. According to its fact sheet, the underlying index includes “pure mortgage players, mortgage insurers, and banks and thrifts that have considerable mortgage loan portfolios in the United States.”
That said, the fund has only 22 percent of its assets invested in mortgage REITs, while the rest of its portfolio is composed of property and casualty insurance firms, homebuilders and regional banks.
There are a lot of choices available to ETF investors so, as always, doing the homework to help determine what best fits your needs is crucial.
At the time the article was written, the author held a position in ITB. Contact Ana Kostioukova at [email protected]. Follow Ana on Twitter @AnaKostioukova.