Housing makes up roughly one-third of Americans’ expenses—the biggest chunk of money coming out of our annual household budgets. But while REIT ETFs and homebuilder ETFs track parts of the U.S. housing market, no single ETF had encompassed the entire market.
To fill that void, Rowayton, Conn.-based investment advisory firm Hoya Capital Real Estate LLC recently rolled out the first ETF that benchmarks the U.S. housing market as a whole. It’s Hoya Capital’s first foray into ETFs.
In all, the Hoya Capital Housing ETF, listed on the New York Stock Exchange, features 100 housing-related stocks—representing companies such as homebuilders, home rental operators and home improvement retailers—that make up the Hoya Capital Housing 100 Index.
NREI recently chatted with Alex Pettee, president and head of ETFs at Hoya Capital, about why his company launched the housing ETF, how REITs are represented in the ETF, and what he sees as the headwinds and tailwinds confronting the U.S. housing sector.
This Q&A has been edited for length, style and clarity.
NREI: Why did you start the Hoya Capital Housing ETF?
Alex Pettee: Creating this ETF made a lot of sense to us both at the investor level, to address a core investment need, and at the ETF product level, to redefine a category that we think is overdue for innovation. A central focus of our research at Hoya Capital Real Estate has been on the macroeconomic trends affecting the U.S. housing market. Specifically, we believe that since the end of the recession, the U.S. has been significantly underinvesting in residential housing on both new and existing homes. The effects of this underinvestment are far-reaching, but they are most acutely visible through rising housing costs—specifically, higher rents and home values.
By tracking an index designed to capture total spending on housing and housing-related services across all housing categories—homebuilding, rental operations, home improvement, and services and technology—we think our ETF captures trends affecting the housing market. Considering that housing costs represent such a significant percentage of total household spending, we think that the ability to capture, or perhaps hedge, rising housing costs represents a core investment need.
Because housing is underrepresented in the broad market-cap-weighted benchmark indexes due to its high degree of private ownership, we think that most investors, particularly renters, lack adequate exposure to housing within their portfolios. While investing in commercial REITs does give investors some of this exposure to real estate, we think that our ETF is a more pure play on the real world investment needs of the typical investor.
NREI: Why wasn’t there a housing ETF before this?
Alex Pettee: There [is] a number of reasons, including the fact that ETF issuers don’t typically like to stray too far from the traditional Global Industry Classification Standard (GICS) categories, but also because advisers have historically viewed the yield-oriented REIT investors in a different realm than the more growth-oriented homebuilder and housing-related investors.
NREI: How are residential and multifamily REITs represented in your ETF?
Alex Pettee: The Hoya Capital Housing 100 Index is designed to track total spending on housing and housing-related services, broken down into four major categories, each weighted based on that sector’s relative contribution to GDP. The index uses a tier-weighted system where companies are equally weighted in each of their respective categories. Breaking free from the market-cap-weighted system allows the index to be significantly more diversified and not dominated by a handful of disproportionally large names.
REITs represent close to 40 percent of the ETF’s total weight, including 20 residential equity REITs, six residential mortgage REITs and two timber REITs. One REIT analyst remarked that it’s like the “United Nations of REITs,” bringing together REIT sectors that are rarely found in a common index, but that are unified under the common umbrella of representing a slice of the broader U.S. housing market. Within the residential REIT category, the index includes 20 of the largest apartment, single-family rental, manufactured housing, lodging, self-storage and seniors housing REITs.
NREI: What headwinds are facing the housing sector that could drag down the ETF’s performance?
Alex Pettee: While we do think that our ETF will be less interest-rate-sensitive than other real estate ETFs due to its wide diversification across multiple equity sectors, it’s impossible to completely avoid the effects of interest rates on real estate equity performance. We saw last year how rising mortgage rates quickly and completely changed the dynamic in the single-family housing market, and how the pullback in rates since late last year seems to have potentially reignited the sector.
Total household formations is the key metric that we think drives our ETF, and formations are driven largely by demographic trends and job growth. Outside of a spike in mortgage rates, a slowdown or reversal in household formations—as we saw during the recession—would probably be the factor that has the most potential to drag on the performance of a majority of the sectors represented in the index. That said, we think our ETF is relatively agnostic to the distribution of households between renting and owning, something that certainly can’t be said about a REIT-exclusive ETF or homebuilder-exclusive ETF.
NREI: What do you view as the housing sector’s tailwinds?
Alex Pettee: While the recent pullback in mortgage rates is a clear short-term tailwind for the housing sector, we think there are significant longer-term tailwinds lifting the housing sector into the next decade. First and perhaps most importantly, is the significant underinvestment in new homes during the post-recession period and the effect that this has had, and will likely continue to have, on rising rents and home values.
While politicians will likely try to address this with politically popular short-term fixes, ultimately the only way that a supply shortage gets resolved—absent a demand recession—is by adding more supply. This is far easier said than done, considering the significant challenges that developers face in the zoning and permitting process, and the increased costs associated with stringent building codes and other regulations that have been a key constraint on supply growth in recent years.
The need for housing doesn’t seem to be going away or getting disrupted anytime soon, so we’re generally bullish on the rental operators during this period of undersupply. But we also believe that the supply shortages will eventually be equalized by slow, but steady growth in new home construction well into the next decade.
The other effect of the underinvestment in new home construction is that the average age of existing homes keeps getting older and older, and when you consider that households significantly deferred home improvement spending in the post-recession period, you’re seeing a substantial tailwind lifting the home improvement and home furnishings categories.