A rising rate landscape continues to rock the foundations of the real estate sector, particularly when it comes to homebuilders, which could benefit the Direxion Daily MSCI Real Est Bear 3X ETF (NYSEArca: DRV), but put persistent downward pressure on the Direxion Daily Homebuilders and Supplies Bull 3X Shares (NYSEArca: NAIL).
With 30-year mortgage rates already surpassing the 5% mark, the cost to finance a home is getting more expensive, clamping down a housing market that has been lagging even as U.S. equities were in the midst of a historic bull run. Compounding the issue is the benchmark U.S. Treasury yield on the 10-year note reaching a new seven-year high.
“It already is affecting housing. Every basis point rate rise already is affecting housing. The run-up in rates over the past year is now weighing increasingly heavily on single-family housing demand, particularly since housing prices have risen so much,” said Mark Zandi, chief economist at Moody’s Analytics. “Affordability is now an issue for many potential home owners. Home sales have gone sideways since the beginning of the year and house price growth is now slowing in many markets so it’s already doing damage. Some of the weakening is due to the tax effect in markets where the deduction was critical.”
DRV seeks daily investment results equal to 300% of the inverse of the daily performance of the MSCI US REIT Index, which is a free float-adjusted market capitalization weighted index that is comprised of equity REITs that are included in the MSCI US Investable Market 2500 Index. DRV invests in swap agreements, futures contracts, short positions or other financial instruments that, in combination, provide inverse or short leveraged exposure to the index.
The effect of rising rates could also be felt in homebuilders as NAIL was down 6.43% as of 2:45 p.m. ET with possibly more pain to come as the tariff war between the United States and China continues to escalate. seeks daily investment results equal to 300% of the performance of the Dow Jones U.S. Select Home Construction Index.
Related: Rising Rates Chase Investors From Big Real Estate ETF
Homebuilders Feeling Effects of Tariffs
The latest round of Chinese tariffs could increase the cost of homebuilding and thus, affect homebuilder ETFs like the iShares US Home Construction ETF (BATS: ITB), SPDR S&P Homebuilders ETF (NYSEArca: XHB) and the Invesco Dynamic Building & Construction ETF (NYSEArca: PKB). Last month, J.P. Morgan lowered its rating for five homebuilders, citing cautiousness in the sector.
“We are becoming more cautious on the homebuilding sector,” analyst Michael Rehaut said in a note. “We expect the housing recovery to remain fairly tepid in 2019.”
As it currently stands, the housing market is already feeling the pangs of rising interest rates crimping homebuyer enthusiasm, but adding to that issue will be the cost to build homes increasing substantially as tariffs have elevated the costs of construction–materials like lumber, steel and aluminum as well as U.S. tariffs on $200 billion in Chinese imports like countertops and furniture could increase construction costs 20% to 30%.
Existing homeowners wishing to perform renovations will also feel the proverbial pain in their pockets. As such, they will seek ways to curb costs or even abandon plans for renovations altogether.
Even if a homebuilder does decide to take on a project, the increased costs eventually get passed on to the consumer, translating in higher real estate prices that will further affect the real estate market. Nonetheless, some market experts feel that the real estate market is underpinned by strong fundamentals despite the wave of rising rates.
“I think fundamentals are strong out there, but I think buyers are going to continue to be involved in the market particularly at the low end,” said Susan Maklari, homebuilder and building products analyst at Credit Suisse. “That will come into play in the builder stocks but we obviously think the upside is not what it was before. … We see the potential for upside but less than we did before.”
“One of the things you probably could see is a seasonal kind of bounce back that happens as investors start to think about 2019, and the spring selling season that comes in early February. There probably could be a sense that even with the 10-year at 3.27 and 30-year mortgages at 4.7, these companies are going to deliver pretty decent growth rates,” Maklari added.
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