For Hoya Capital president Alex Pettee, there’s big opportunity for ETF investors to capture potential upside in the U.S. housing market.
Pettee says it’s one of the largest asset classes that he says “has not been properly defined for investors up to this point.”
While there are popular ETFs that track the housing market such as the SPDR S&P Homebuilders ETF (XHB) and the iShares U.S. Home Construction ETF (ITB), Pettee and his team recently launched their own fund in the space: the Hoya Capital Housing ETF (HOMZ).
Pettee recently caught up with ETFtrends.com to discuss the housing market sector and its HOMZ ETF.
1. What do you see as the shortcomings in existing real estate investment products?
Many of the most exciting innovations happening across the entire financial services industry are happening right here in the ETF sector, and for good reason: Millennials use ETFs at nearly twice the rate of Boomers, and forward-looking financial advisors are understanding the need to adapt to the investing style of the next generation. Millennials like myself grew up investing in ETFs, we love and trust ETFs, and I think you’d be hard-pressed to find a self-directed millennial that owns a single mutual fund. We’re naturally more risk-averse and skeptical of investment styles and managers that claim outperformance and are looking more for sensible asset allocations that are customized and titled towards our particular life stages and goals.
While we’ve seen tremendous innovation across the ETF sector in thematic and outcome-driven funds, the real estate category has been slow to innovate. As a specialized real estate-focused RIA and heavy user of real estate ETFs in our client’s portfolios, we saw a significant gap in the current product lineup and the chance to bring innovation to a sector that has long been dominated by traditional market cap weighted sector indexes and simple sector-indexes that were constrained to a single sub-segment of the housing market. It continues to surprise us that until HOMZ, no ETF viewed the US housing market – the largest and arguably the most important asset class in the world – as a distinct investible sector at the ETF-level. There’s a half-dozen artificial intelligence and bitcoin ETFs, but there wasn’t even an ETF that has the word “housing” in it!
2. What role does HOMZ serve in existing portfolio? What are some examples of target investors and their use case?
HOMZ reflects this investor-driven, asset allocation model of investing where portfolios address a real investment need of the client. In this case, HOMZ addresses perhaps the most pressing investment need affecting the younger generation: Housing. Locked out of the ownership markets by unaffordable home values, elevated student debt levels, and rising rents that make it impossible to save up for a down payment, renters are tremendously exposed to the negative effects of rising rents and housing costs. Put simply, HOMZ is the ETF for renters. While there are numerous other investment-use cases including as a source of diversification and potential outperformance in a portfolio, we think that it’s use-case by renters as a way to get their foot in the door into the housing markets is the most compelling of all. We believe that more than any other ETF, HOMZ gives investors the closest thing there is to physical residential real estate ownership in an ETF wrapper.
Additionally, because the index is unbound by the traditional single-sector classifications, each of the housing segments may respond in diverse and potentially counterbalancing ways to macroeconomic factors including interest rates, which have been a thorn in the side of REIT investors for most of the post-recession period. Many investors we’ve spoken to see HOMZ as the “growth” side of the real estate industry, contrasting with the traditional yield-oriented REIT funds that are not always suitable for younger and growth-oriented investors. Ironically, the need for real estate in an investor’s portfolio peaks during their renting years, but that’s typically the time that advisors have the lowest amount of real estate allocated to that investor due to the bond-like characteristics of traditional REIT funds. We think that HOMZ allows asset allocators to put real estate into a growth-oriented portfolio, which in itself fills a significant investment need.
Finally, we think that HOMZ will eventually be viewed by the large institutional investors like hedge funds and insurance funds as the most direct and efficient way to express a directional view on the US housing markets in the ETF wrapper, while also serving as a possible hedge against existing exposures. The efficiency and liquidity of the underlying basket were significant considerations during the index design process for this reason and with 100 highly-liquid domestic companies with no single name representing more than 3% of the index at rebalancing, we’re excited about the potential of HOMZ as an efficient institutional investment vehicle.
3. Why is there a need to better track US housing?
The US has been significantly underinvesting in residential housing on both new and existing homes. The effects of this underinvestment are far-reaching, but are most acutely visible through rising housing costs- specifically, higher rents and home values. This underinvestment in housing is happing at the same time that we’re seeing some of the strongest demographics and economic backdrop for household formation growth in a generation. 2018 saw the strongest rate of household formations since 1985, powered by rising real wage growth and another year of robust job growth. The conditions in housing markets are creating a “perfect storm” for rising rents and home values, and investors that are on the outside looking in are feeling the negative effects.
As a percent of household spending, housing costs are now a third of spending for the average American according to the Consumer Price Index, up from around 15% back in the 1950s and it’s certainly not uncommon to hear of millennials in major metro areas paying upwards of 50-60% or more of their average annual income towards rents. Housing costs are the largest single expenditure category for the average American household and we don’t see that changing anytime soon.
While housing is 33% or more of average household spending, housing and real estate represent less than 5% of the weight of the S&P 500. Because housing and real estate has such a high percentage of private ownership, they are tremendously under-represented in the traditional stock indexes. For investors in a simple S&P 500 portfolio, that a huge mismatch between the asset side of the investor’s balance sheet and the liability-side, particularly for renters who lack the direct exposure to housing. This is one of the shortfalls of market-cap weighted indexes- put simply, they are reflecting what’s happening on “Wall Street” while indexes like HOMZ are representing what’s happening on “Main Street.”
By tracking an index designed to capture total spending on housing and housing-related services across all housing categories – home building, rental operations, home improvement, and services and technology – we think that HOMZ captures these trends affecting the housing market. At the household-level, rising housing costs affect nearly every American in some way, but renter households are particularly exposed. Considering that housing costs represent such a significant percentage of total household spending, we think that the ability capture or perhaps “hedge” rising costs represent a core investment need.
4. How do existing REIT ETFs fail to accurately represent the performance of the US Housing market?
Before HOMZ, there were REIT ETFs and then there were Homebuilder ETFs, and the each operated in their own investment universe. Each represents a relatively small slice of the broader housing market. No ETF viewed the US housing market – arguably the most important asset class in the world – as a distinct investible sector at the ETF-level. Again, we felt that this reflects the lack of innovation and adaptation to the investor-driven asset allocation.
The REZ, a residential REIT ETF has been among our favorite ETFs for many years. We’ve written research reports on it, and noted the absolutely phenomenal performance relative to the broader REIT index – it’s outperformed by a wide margin on essentially every recent measurement period. During the index development process, through backtesting we discovered that the source of this performance was driven not by the particular index construction or holdings, but rather by the tailwinds driving the performance of the housing sector- notably the trends of limited supply and strong demand driving ‘real’ growth in housing costs. We discovered that adding in other non-REIT housing components to the index, weighted at the GDP level to track total spending on housing and housing-related services, led to even better risk-adjusted performance than an index of REITs alone. And because this naturally leads to a more relatively more tax efficient and growth-oriented index, we felt that there was a very clear rationale for creating the Housing 100 index.
Additionally, when advisors tell their clients they’re allocated to “real estate,” we think the image in the client’s mind is different from what they’re really getting. Our clients are shocked to learn that the single largest holding in some of the largest market cap-weighted real estate indexes is not apartments or office buildings. It’s a cellular antenna operator. Followed by a mall owner. Followed by another cell antenna operator. This is a problem for many advisors, especially when these non-core sectors are underperforming. We think HOMZ helps to alleviate some of those potential perception issues between advisors and their clients, as HOMZ is more representative of client’s real-world interactions with the real estate market.
5. How do existing Homebuilder ETFs fail to accurately represent the performance of the US Housing market?
At the homebuilder level, we have always wondered how homebuilder ETFs came to represent the entire US housing market, considering that they represent such a small slice of total housing market activity. Perhaps because there was simply nothing else at the ETF-level until the launch of HOMZ, the media has always used XHB and ITB as proxies for the performance of the housing market despite the fact that these ETFs almost exclusively capture the single family market – essentially ignoring the other 40% of the housing market – but also focus only on one component of the market: new construction. There is no Zillow, Redfin, RealPage, or Corelogic, all companies that are really on the front-lines of the housing industry.
With more awareness around the impact of rising housing costs and the real-world exposure that investors face, I think that advisors will see HOMZ as a core piece of an asset allocation to address the actual practical exposures that their clients face. HOMZ combines not only residential REITs and homebuilders, but also the housing-related categories that are nowhere to be found in either realm, most notably the emerging real estate services firms like Zillow, Redfin and CoreLogic. For these reasons, we believe that HOMZ provides a modernized and highly intuitive evolution in the homebuilding and real estate categories and we’re really excited about it’s potential.
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