After slowly trending up in the years after the financial crisis, new home sales spiked exponentially in the latter half of 2020.
Low mortgage rates and people spending more time at home were the factors driving this uptick in housing demand, bringing levels relatively close to the peak before the housing bubble burst in 2008.
Homebuilder ETFs were a natural beneficiary of this spike in demand. Both the iShares U.S. Home Construction ETF (ITB) and the SPDR S&P Homebuilders ETF (XHB) outperformed the broad-market SPDR S&P 500 ETF Trust (SPY) over the course of 2021.
Signs Of Softening
However, with rates on the rise this year, there are signs that this might have the effect of cooling demand. Data released on Feb. 9 showed that mortgage refinance applications had fallen by 7% for the week and were 52% lower than the prior year.
Refinance applications are more sensitive to rate moves than new mortgage applications, since refinancing is optional. And many homebuyers have already locked in low rates over the past several years.
But mortgage applications are also declining, with the same report showing a 12% year-over-year decline. Performance of homebuilder ETFs so far this year suggests the market is picking up on this as well.
The iShares U.S. Home Construction ETF (ITB) has fallen by 15.8% so far this year, while the SPDR S&P Homebuilders ETF (XHB) is faring only slightly better, down 14.3%. REIT funds, on the other hand, seem to offer slightly more protection.
Though both homebuilders and REIT funds are real estate plays, they can perform differently based on the market environment.
Homebuilder ETFs like ITB and XHB hold equities of companies that are involved in homebuilding, as well as related companies including manufacturers, sellers and distributors of housewares and home furnishings.
Courtesy of FactSet
This broad definition of “home construction” explains Home Depot and Sherwin-Williams Company’s presence in the top holdings of this ETF.
REIT ETFs provide exposure to companies that own and operate income-producing real estate properties. Both the Schwab U.S. REIT ETF (SCHH) and the iShares Global REIT ETF (REET) offer exposure to a wide range of REITs, including industrial, retail and residential REITs. REITs are also obligated to distribute 90% of income in the form of dividends.
Pros & Cons
This feature means that REITs are sensitive to rising rates, as higher rates can make this asset class less attractive, all else being equal. But even taking rising rates into consideration, REITs could potentially be better situated for the environment going forward.
As rising rates push buyers out of the housing market, this could serve to increase demand for rentals, increasing prices, which historically has been beneficial for REITs.
Inflation is also benefiting other REITs, such as warehouse giant Prologis, which is the top holding in both SCHH and REET. Prologis’ recent earnings report showed that the company was able to increase rental rates on renewed leases by 33%.
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Meanwhile, an acceleration of return-to-office plans could boost office REITs, which make up nearly 11% of REET and 7% of SCHH.
Should the positive effects on REITs from higher levels of inflation outweigh the effect of rising rates, REIT ETFs could continue to outshine homebuilder ETFs in the near term.