Home Sales Hit Fastest Pace in Three Years

March 22, 2013

The National Association of Realtors indicates that the sale of previously owned homes hit a three-year high in February, a sign the economy is definitely on the mend. However, it's not too late to join the party. Here are several ideas I believe will allow you to benefit from this ongoing housing trend while also limiting your downside.

Breaking Down The ETF

 The easiest way to benefit from an improving real estate market is to invest in an ETF that captures many of the companies participating in that growth. You've likely heard this story before given the success of homebuilders in the past year. Up till now it had been a housing recovery led by new home construction. The latest stats about previously owned homes would seem to indicate the same is happening with resales. Realtors have to be very happy about the news.

 The two biggest funds in terms of assets under management are the SPDR S&P Homebuilders ETF (ARCA:XHB) with $2.8 billion and the iShares U.S. Home Construction ETF (ARCA:ITB) with $2.4 billion. Both have a similar number of stocks with the XHB holding 37 companies to 29 for the ITB. That's where they go their separate ways. The ITB over the past year through March 20 has achieved a total return of 66.4% compared to 44.3% for the XHB. There's a simple explanation… the ITB portfolio is 65% invested in homebuilders while the XHB is more diversified with just 29% allocated to them. Over the last three years, the two funds have achieved almost identical returns with the XHB's being slightly less volatile. For this reason and the fact I favor equal weighted ETFs over those that are capitalization weighted (cap-weighted funds tend to get overweighted in the top 10 holdings), of the two I'd go with the XHB.

Betting On Resales

 As the February numbers indicate, resale housing is picking up. The temptation is strong to own companies that invest in residential mortgages; the easiest way to do this is through the Market Vectors Mortgage REIT Income ETF (ARCA:MORT), which tracks the performance of publicly traded mortgage REITs. The current SEC 30-day yield for MORT is 9.94% and its year-to-date return through March 20 is 15.3%. While awfully enticing, this kind of yield doesn't come without risk.

 Real estate advisor Brad Thomas in a January article for Seeking Alpha said this about mortgage REITs: "During the last rising rate cycle (2003-2005), short-term interest rates rose and the yield curve went negative - alas, mortgage REITs went in the ditch. During that period, yields went from 15% to 4% (dividend cuts) and total returns, in the same period, were around negative 30%." While the likelihood of short-term interest rates rising tomorrow or the next day is non-existent, they will eventually go up. When they do, look out below. For this reason I'd pass on mREITs.

Mortgage Rates Hit 2.50% (2.90% APR)

 The best and safest bet on the single family residential market in my opinion is to buy shares in The Blackstone Group (NYSE:BX), the New York-based private equity firm run by Stephen Schwarzman. Through its real estate platform, Invitation Homes, it has purchased 20,000 single family homes primarily in Florida, Arizona and California. Spending $3.5 billion, it will fix them up, rent them out and eventually sell them off for a profit. It's not the only big institution investing in residential real estate. However, its diversity of assets, which includes brands such as Jack Wolfskin, Hilton Hotels, Sea World, Orangina and many others, makes it the least risky in my opinion.

The Ultimate ETF

 The best part about owning this investment is you don't have to pay a management fee. It's the cheapest ETF going. Berkshire Hathaway (NYSE:BRK.B), while known for its insurance businesses, also has several housing related businesses in its stable including Clayton Homes (manufactured and modular homes), Shaw Industries (carpet, hardwood, etc.), Johns Manville (insulation, roofing), Benjamin Moore (paint) and Acme Brick.

 Its most relevant business in the context of this article is Home Services of America, its real estate brokerage that last October announced it was uniting with Brookfield Asset Management's (NYSE:BAM) brokerage; together they would operate as Berkshire Hathaway Home Services. The combined entity will have more than 1,700 offices across the U.S. Should the resale markets continue to improve, Berkshire Hathaway will definitely be in for a bigger payday.

Bottom Line

 I've made several suggestions about how to play the continuing improvement in the housing market. However, in order to take advantage of Berkshire Hathaway's diversification while also benefiting from an equally impressive rebound over the past year by the financial services sector, I'm recommending that you buy the Financial Select Sector SPDR Fund (ARCA:XLF), which has Berkshire Hathaway as its second largest holding with a weighting of 8.35%. The fund gives you good exposure to housing albeit in a very indirect way. Long-term, though, you're providing yourself with greater downside protection.

 At the time of writing, Will Ashworth did not own any shares in any of the companies mentioned.

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.