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Builders NAIL it While Renters Reel

May 27, 2020

Real estate investors have been in a quandary since the start of the global COVID-19 pandemic. What will housing demand look like in the age of social distancing? How will prices shift when more and more individuals are out of work? What happens to property prices and rental rates as these economic tides shift?

Unfortunately, the answers to these questions will take months, if not years, to resolve, and the answers may not be clear cut even then.

At the moment though, investors seem to have faith that the housing market will retain the resilience it built up over the previous few years, as evidenced by the strength seen among homebuilder and supplier stocks represented in the Direxion Daily Homebuilders & Supplies Bull 3X Shares (NAIL), which tracks the Dow Jones U.S. Select Home Construction Index (DJSHMBT). The ETF has managed to climb about 100% since the start of April while taking in roughly $75 million of inflows.The same can’t be said for confidence in the real estate market, which has seen much more volatility since the onset of the pandemic. The array of REITs represented in the MSCI US IMI Real Estate 25/50 Index (M2CXVGD) underperformed the broader market dramatically in March and April. And since April, the Direxion Daily MSCI Real Estate Bear 3X Shares (DRV) has taken in more than $60 million in inflows, more than three times as many as the Direxion Daily MSCI Real Estate Bull 3X Shares (DRN), suggesting traders are more willing to play downside in the sector.

Below, we’ll look at what signals are driving these forces and how investors might best anticipate the real catalysts influencing real estate.

Homebuilders: Home Supply Vs. Mortgage Rates

The big story in housing demand now, as it has been for the past few years, is the record low supply of houses on the market. FreddieMac recently put out an estimate that the housing deficit ranges anywhere from 2.5 to 3.3 million homes. The pressure from this shortage has helped boost the S&P/Case-Shiller U.S. National Home Price Index from an almost 10-year low following the 2008 housing market crash to new all-time highs starting in 2017.

While the tight supply may price out some prospective homebuyers, the high costs are being counterbalanced by record-low mortgage rates. According to data from FreddieMac, the average 30-year mortgage rate is currently hovering at around just 3.25% while 15-year rates are averaging 2.75%. This puts even the high cost of homes within the reach of more buyers. And with the Federal Reserve signaling its intention to keep rates near-zero, mortgage rates will likely stay near their current lows.

US Home Mortgage 15 Year Fixed National Avg & US Home Mortgage 30 Year Fixed National Avg from bankrate.com. Data as of May 2020.

As a result of these factors, it’s unsurprising that the revenue figures among homebuilding have reflected similar demand. In its most recent earnings announcement, construction giant D.R. Horton, Inc. managed to grow its sales by nearly 9% year-over-year. At the same time, competitor Lennar Corporation boosted its quarterly figures by more than 16%. Both companies are higher by more than 40% over the past two months.

Other companies with exposure to homebuilding, including retailers and suppliers like Home Depot, Lowe’s and Sherwin Williams have also seen strong investor interest in the post-pandemic market, gaining anywhere from 35% to more than 70% since mid-March.

While the long-term viability of these trends is impossible to predict, the momentum of these macro trends and the built-up pressure in the housing market means there is likely enough momentum to support the market for the time being.

REITs: Property Values vs. Rental Rates

The factors supporting home prices are not quite as beneficial to rental properties, though they also are not entirely negative.

Like housing, commercial real estate had seen a similar run-up in property values prior to the pandemic. According to Green Street Advisor’s Commercial Property Price Index, which is a composite price index across a variety of commercial property types, commercial real estate saw a strong rebound following the 2008 financial crisis and was also consistently hitting all-time highs for the better part of the past decade.

However, given the widespread shutdowns that resulted from efforts to slow the spread of COVID-19, the CPPI saw its most significant monthly drop-off since 2008, falling almost 9% between March and April.

Source: Green Street Commercial Property Price Index. Data as of May 2020. Past performance is not indicative of future results. One cannot invest directly in an index.

While there are a host of factors that influence values across all of the segments represented in the index, the drop off does signal that the high property valuations in commercial real estate might see continued pressure, especially since values were already leveling off somewhat in recent years thanks to an upswell in the number of new constructions in the multifamily and office/retail markets.

The effects of the pandemic on these trends have been almost immediate, with demand falling sharply and pushing absorption rates into the negative for the first time in years, according to data compiled by NAREIT. While the effects of this negative pressure on rental rates has yet to work its way through to owners and tenants, some REITs are increasingly looking at a supply glut that could drive down rent prices.

While some REITs have remained resilient to these trends, especially those that don’t have exposure to residential, retail or industrial sectors like Equinix and Prologis, the same can’t be said for others. Equity Residential, Public Storage and Simon Property Group are just a few heavily-traded REITs that still find themselves at or near multi-year lows.

The Real State of Real Estate

Again, the effects of the pandemic are going to stick with the U.S. and global economy for years to come. The long- and even medium-term fallout for the real estate market may look entirely different from what investors are seeing now.

Going forward, traders should keep a close eye on the ebb and flow of property values in both residential and commercial real estate to get a sense of how demand is influencing owner pricing across the different segments of the industry.

Regardless of where prices go, renters and buyers alike will still need a roof and four walls to call home (or work). However, the type of structure they can afford is less cut-and-dry.

Related Leveraged ETFs: 

The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted. 

For the funds’ standardized and most recent month end performance click here (www.direxion.com/etfs)

Short-term performance, in particular, is not a good indication of the fund’s future performance, and an investment should not be made based solely on returns. Because of ongoing market volatility, fund performance may be subject to substantial short-term changes.

NAIL as of 3/31/2020

DRN and DRV as of 3/31/2020

These leveraged ETFs seek investment results that are 300% of the return of its benchmark index for a single day. Investing in a Direxion Shares ETF may be more volatile than investing in broadly diversified funds. The use of leverage by an ETF increases the risk to the ETF. The Direxion Shares ETFs are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged investment results and intend to actively monitor and manage their investment.

An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 866-301-9214 or visit our website at direxioninvestments.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.

Market Disruptions Resulting from COVID-19. The outbreak of COVID-19 has negatively affected the worldwide economy, individual countries, individual companies and the market in general. The future impact of COVID-19 is currently unknown, and it may exacerbate other risks that apply to the Funds.

Shares of the Direxion Shares are bought and sold at market price (not NAV) and are not individually redeemed from a Fund. Market Price returns are based upon the midpoint of the bid/ask spread at 4:00 pm EST (when NAV is normally calculated) and do not represent the returns you would receive if you traded shares at other times. Brokerage commissions will reduce returns. Fund returns assume that dividends and capital gains distributions have been reinvested in the Fund at NAV. Some performance results reflect expense reimbursements or recoupments and fee waivers in effect during certain periods shown. Absent these reimbursements or recoupments and fee waivers, results would have been less favorable.

Direxion Shares Risks: An investment in the ETFs involves risk, including the possible loss of principal. The ETFs are non-diversified and include risks associated with concentration that results from an ETF’s investments in a particular industry or sector which can increase volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. The ETFs do not attempt to, and should not be expected to, provide returns which are a multiple of the return of their respective index for periods other than a single day. For other risks including leverage, correlation, daily compounding, market volatility and risks specific to an industry or sector, please read the prospectus.

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