Build it and they will come: Homebuilder ETFs are enjoying record returns after a torrid 2022

Home building and housing sector sentiment is on the rise.

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• Homebuilder ETFs are enjoying a strong 2023, defying conventional stock market wisdom.
• The largest homebuilder ETF, the iShares U.S. Home Construction, has risen 46% year-to-date. 
• High interest rates usually stifle demand for new homes, but not this year: the housing market is holding firm. 

Exchange-traded funds investing in homebuilders are on a roll this year, enjoying record returns despite challenging market conditions.

That defies conventional market wisdom that developers and related investments come under pressure in an environment of rising interest rates, which tend to reduce demand for housing. This time around, however, demand for newly built houses has picked up due to a slump in the supply of existing ones.

And that's fueling a rally in homebuilder stocks and funds that invest in them.

The largest exchange-traded fund focusing on homebuilders, the iShares U.S. Home Construction ETF, has surged more than 46% year-to-date, while the SPDR S&P Homebuilders ETF jumped 39%. Those returns dwarf a 19% gain on the broader ETF market benchmark, the iShares Core S&P 500 ETF.

The gains mark an impressive rebound after a torrid 2022 – which saw both funds fall by over a quarter after the Federal Reserve began its war against inflation by raising interest rates sharply. The central bank has boosted benchmark rates by 525 basis points since early 2022, taking them to a 22-year high.

Usually, rate hikes make mortgages costlier, damping housing demand from new buyers.

While these effects are evident in the current economic climate, the high rates have also discouraged potential sellers – as they would have to take on a higher mortgage elsewhere.

Low turnover, coupled with a buoyant jobs market, means the housing market has remained well-supported even as the Fed's tightening cycle reaches its peak. 

In fact, a decade-long housebuilding shortfall has given homebuilding ETFs the chance to capitalize on historically low construction figures.

""During the quarter, we continued to see the housing market normalize and recover from the Fed's 2022 aggressive interest rate hikes," Stuart Miller, executive chairman of homebuilder Lennar Corp., said in the company's second-quarter earnings release. "Demand has accelerated, leaving the market to reconcile the chronic supply shortage derived from over a decade of production deficits,"  "Simply put, America needs more housing."

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