Five Ways to Play The Housing Recovery (MBB, GNMA, CMBS, REM, REZ, FNIO, RTL, ICF, IYR, FTY, ITB)

Karen Schenone: Looking at the iShares app on my iPad this weekend, I was surprised to discover that the iShares Dow Jones US Home Construction ETF (ITB) has been a top performing fund year-to-date.  While past performance is certainly not indicative of future returns, I thought it might be a good time to take the temperature of the US housing recovery and review options for accessing real estate as an investment.

First, is a housing recovery imminent?  The short answer is maybe.  A recent BlackRock Institute paper asserts that finally, after national housing prices slid 36% from their peak, we’re at or near the bottom.  In addition, with the Fed injecting liquidity into the bond market, mortgage rates have fallen to all-time lows.  These lower borrowing rates have caused a 30% increase in existing home sales and housing starts since their trough in the summer of 2010.  While credit availability is restricted and remains accessible primarily for high quality borrowers, the mortgage affordability index indicates it’s actually a good time to buy a house.  Commercial real estate prices in major markets are also up 41% since the trough, according to the Moody’s/RCA Commercial Property Price indices.

Investors looking to play this space using ETFs have several unique choices, each with a varying level of risk (see chart below). Different stocks, bonds and REITs allow investors to tailor their exposure to certain types of real estate investments.   Starting with the less risky end of the spectrum, let’s review some of the options.

  • Agency mortgage backed securities (MBS) – These are bonds that get their cash flow from loans on homes.  Most funds that offer access to MBS hold mortgage pass-through securities, which simply means that payments made by individual homeowners are passed to the holder of the mortgage-backed security.  Adding an additional level of safety, the timely payment of principal and interest for MBS is guaranteed by US government agencies such as Fannie Mae, Freddie Mac and Ginnie Mae.  The underlying homeowners have the right to prepay their mortgages early resulting in prepayment risk and less certainty around the timing of cash flows relative to other bonds.

Potential iShares solutions:
iShares Barclays MBS Bond ETF
(NYSEARCA:MBB)
iShares Barclays GNMA Bond ETF
(NASDAQ:GNMA)

  • Commercial Mortgage Backed Securities (CMBS) – The underlying cash flow from CMBS comes from loans on office buildings, apartments, retail stores and industrial properties. Unlike residential MBS, these contain more credit risk since there is not a government guarantee.  Note that all of the bonds in the iShares Barclays CMBS ETF (CMBS) must be investment grade in order to be eligible for the underlying index.

Potential iShares solution:
iShares Barclays CMBS Bond Fund
(NYSEARCA:CMBS)

  • Mortgage REITs – These real estate investment trusts lend money directly to real estate owners or buy mortgage backed securities.  Often mortgage REITs are using leverage to increase the income derived from their loans or portfolio of securities. To maintain their status as a REIT, they must pass along 90% of annual income to shareholders.  Yields on mortgage REITs are currently just under 12%.

Potential iShares solution:
iShares FTSE NAREIT Mortgage Plus Capped Fund
(NYSEARCA:REM)

  • Equity REITs – Equity REITs own and operate income-producing properties and also pass along 90% of annual income to shareholders.  They can be sub-divided into different property types: Residential (REITs that are invested in apartments, manufactured homes, healthcare facilities and storage facilities), Industrial (REITs that are invested in industrial properties, office buildings and mixed use facilities), Retail (REITs that are invested in shopping centers, regional malls and free standing stores) , and Hybrids (a mix of equity and mortgage REITs).

Potential iShares solutions:
iShares FTSE NAREIT Residential Plus Capped  Fund
(NYSEARCA:REZ)
iShares FTSE NAREIT Industrial/Office Capped Fund
(NYSEARCA:FNIO)
iShares FTSE NAREIT Retail Capped Fund
(NYSEARCA:RTL)
iShares Cohen & Steers Realty Majors
(NYSEARCA:ICF)
iShares Dow Jones U.S. Real Estate
(NYSEARCA:IYR)
iShares FTSE NAREIT Real Estate 50 Fund
(NYSEARCA:FTY)

  • Equity of home construction companies – This sector contains the common stock of companies that develop residential and commercial real estate, such as DR Horton and Toll Brothers.  It also includes home improvement suppliers such as Home Depot and Lowe’s, and home furnishing companies.

Potential iShares solution:
iShares Dow Jones U.S. Home Construction Index Fund
(NYSEARCA:ITB)

Written By Karen Schenone From The iShares Blog

Karen Schenone, CFA, is a fixed income strategist within BlackRock’s Portfolio Solutions group with a focus on the iShares suite of exchange-traded funds. She works directly with the iShares sales force to serve clients and assists in the product development process for new fixed income ETFs.

Prior to joining BlackRock, she was an investment research analyst at Laird Norton Tyee, providing investment solutions for high net worth clients through asset allocation and security selection decisions. Mrs. Schenone began her career as a portfolio analyst and trader in the treasury department of Washington Mutual Bank. Ms. Schenone earned a Bachelors of Business Administration in finance from The University of Texas at Austin and is a CFA Charterholder.

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