A Quick Guide To REIT ETFs [Vanguard REIT ETF, iShares Dow Jones US Real Estate (ETF), SPDR Dow Jones REIT ETF]

reitThe year 2013 has been an unusual one for the Real Estate Investment Trust (REIT) industry with stock prices of this special hybrid asset class seeing both highs and lows. Particularly, the concerns surrounding the interest rate environment emanating from the Federal Reserve’s economic stimulus moves kept the industry in the headlines in the second half of the year.

And for the first time in five years, the listed U.S. REIT stocks’ return underperformed the broader equity market as per the National Association of Real Estate Investment Trusts (NAREIT). On a total return basis in 2013, the FTSE NAREIT All REITs Index climbed just 3.2% compared to the S&P 500’s decent 32.4% run.

Finally, convinced by the consistent pickup in economic activity and labor market improvement, the Fed started tapering its stimulus in December. Further, in January, the Fed cut its monthly bond buying to $65 billion from $75 billion in December.

In spite of this desperate stance taken by the Fed, the economic data released earlier this year was not as robust as expected. Coupled with the emerging economy woes, the benchmark indices in fact became volatile resulting in a soft start to this year.

REITs Back in Focus

In this backdrop, the focus again shifted to REITs, which more often than not, tend to perform better when stocks from other industries are down. On a total return basis, the FTSE NAREIT All REITs Index gained 3.4% in January, compared to the S&P 500’s decline of 3.5%.

Further in February, with increased confidence regarding the economic recovery, the FTSE NAREIT All REIT Index climbed 4.7%, a notch higher than the 4.6% gain experienced by S&P 500. (Read: Play rising rates with these ETFs)

While the gradual reduction in the Fed’s support could lead to higher interest rates in the long run, thereby hurting the rate-sensitive business of REITs, we believe that broader market concerns will not cart off the prospects of gaining from portfolio diversification that this distinct asset class offers.

REITs, which basically own and manage income-producing real estate (such as apartments, offices, hotels, industrial or other facilities or invest in mortgages or mortgage-backed securities attached with properties), let its shareholders enjoy ownership benefits of the real estate without actually becoming landlords.

These assets perform differently based on individual market dynamics. Therefore, investors have the opportunity to gain maximum leverage from the changes seen time to time in performances by these assets.

Consumer Confidence Growing

A decent GDP report and encouraging U.S. retail data clearly indicate growing consumer confidence, which is further reinforced by the Fed’s new-found faith in the economy.  However, the Consumer Confidence Index registered a moderate decline in February to 78.1.

With consumer spending accounting for over two-third of the U.S. economic activity, we believe that this is an opportune moment for those companies that provide real estate support to the sectors which directly benefit from these activities. Alongside, with the Fed intending to keep the interest rates near zero despite the tapering and until unemployment rate drops below 6.5%, REITs will continue to benefit.

Dividends Still Are Key Attraction

Dividends continue to be the key attraction of this industry. With the U.S. law requiring REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders, yield-hungry investors still have a large appetite for such stocks. This has enabled the industry to stand out and gain a footing over the last 15–20 years.

As of Jan 31, the dividend yield of the FTSE NAREIT All REITs Index was 4.16%. The yield of the FTSE NAREIT All Equity REITs Index was 3.65% while the FTSE NAREIT Mortgage REITs Index yielded 9.73%. Clearly, the REITs continued to offer solid yields and outpaced the 2.09% dividend yield offered by the S&P 500 as of Jan 31.

Capital Access

Accessibility to capital is a prime factor in the REIT industry and 2013 has been a notable one from this angle. A total of $76.96 billion was raised by listed REITs compared to $73.33 billion in the prior year. A solid IPO market in 2013 primarily made it happen.

During the year, 19 IPOs helped in raising a total of $5.71 billion, marking the highest amount raised in the largest number of IPOs since 2004. REITs have further raised $4.4 billion in initial, debt and equity capital offerings in Jan 2014.

Exploring the Sector through ETFs

In this environment, we believe this is the right time to explore the sector through ETFs so as to reap the benefits in a safer way (See all Real Estate ETFs here). Considering the prospects for return from dividend income and capital appreciation, we have tracked the following REIT ETFs, which could be worth considering:

Vanguard REIT ETF (NYSEARCA:VNQ)

The fund, launched over nine years ago, seeks investment results by tracking the performance of the benchmark – MSCI US REIT Index – which is used to gauge real estate stocks. The fund consists of 131 stocks, which acquire office buildings, hotels, and other real property. The top three holdings are Simon Property Group Inc. (SPG), Public Storage (PSA) and Prologis, Inc. (PLD). It charges 10 basis points in fees (as of May 28, 2013). VNQ has managed to attract $35.3 billion in assets under management till Jan 31, 2014.

iShares U.S. Real Estate ETF (NYSEARCA:IYR)

Launched in 2000, IYR follows the Dow Jones U.S. Real Estate Index that measures the performance of the real estate industry of the U.S. equity market. The fund comprises 101 stocks with top holdings including Simon Property Group Inc., American Tower Corporation (AMT) and Crown Castle International Corp. (CCI). The fund’s expense ratio is 0.45% (as of Dec 31, 2013) and the 12-month yield is 3.65% (as of Jan 31, 2014). It has $4.7 billion in assets under management as of Mar 6, 2014.

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