Real estate investment trust (REIT) investors who sulked last month due to weak performance should cheer up now. This is because, contrary to consensus expectations, benchmark treasury yields have been coming down. On top of this, the Fed has been extremely cautious and will likely be more so given the global growth worries. All of this has been a godsend for the interest rate sensitive REIT industry.
While the interest rate issue has hogged the limelight in recent weeks, one should not forget that the shareholders of this special hybrid class can also gain from the individual market dynamics of different asset types (malls, shopping centers, apartments, offices, hotels, industrial or other facilities) owned and managed by the REITs.
The low interest rate environment, though not perpetual, should lead to more consumption spending. Consequently, the majority of these asset types are expected to benefit.
A recent study by the CBRE Group Inc. (CBG) revealed a solid recovery for the U.S. commercial real estate market in the third quarter of 2014. The study says that office vacancy rates witnessed a 40 bps sequential decline to 14.1%, denoting the steepest plunge since the second quarter of 2006. National industrial availability posted a 20 bps decline from the prior quarter to 10.6% while retail availability also moved 20 bps south for the quarter to 11.5%.
Nevertheless, rates have to rise eventually in line with an improving U.S. economy. Rising rates will no doubt be a headwind for REITs, but we strongly feel that the associated economic opportunity will more than offset the higher financing cost that raised interest rates will signify. Yet, in the near term, the weak retail sales report for September and continued sluggish business trends remain our concern. (Read: ETFs Riding (Read: MLP ETFs—A better choice in a market slump?)
Statistics Not Too Discouraging
The varying perditions for the timing of interest rate hike resulted in hiccups for the REITs. But the battered September figures could not eat away all the returns that this industry has reaped since January.
As per the National Association of Real Estate Investment Trusts (NAREIT), the FTSE NAREIT All REITs Index dipped 5.6% versus the 1.4% decline in the S&P 500 Index. But in the January to September period, the FTSE NAREIT All REITs Index gained 13.1% against the 8.3% gain for the S&P 500.
Despite global worries, economic indicators like the jobs report and Institute of Supply Management (ISM) numbers recently indicated an ongoing improvement albeit at a slow pace.
This economic betterment will lead to improved disposable income, higher occupancy levels and rent, rise in property valuation, and finally improvement in total income and dividend level.
Dividends Remain Key Attraction
Along with the capital appreciation, yield-hungry investors still have a large appetite for these stocks as the U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends.
As of Aug 29, the dividend yield of the FTSE NAREIT All REITs Index was 3.98%. The yield of the FTSE NAREIT All Equity REITs Index was 3.47% while the FTSE NAREIT Mortgage REITs Index yielded 10.01%. Clearly, the REITs continued to offer solid yields and outpaced the 1.99% dividend yield offered by the S&P 500 as of that date.
REITs have also been much active in the capital market this year and this gives cues of a rise in investors’ confidence in this sector and their willingness to pour money into it. As of Aug 29, REITs raised $41.3 billion in initial, debt and equity capital offerings in 2014.
Last year too was notable with listed REITs raising a total of $76.96 billion compared with $73.33 billion in the prior year. The increase was backed by a solid IPO market.
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. 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 (VNQ)
The fund, launched in 2004, 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 138 stocks, which acquire office buildings, hotels, and other real property. The top three holdings are Simon Property Group Inc. (SPG), Public Storage (PSA) and Equity Residential (EQR). It charges 10 basis points in fees (as of May 27, 2014). VNQ has managed to attract $43.1 billion in assets under management till Sep 30, 2014.
iShares U.S. Real Estate ETF (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 110 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 0.43% (as of Sep 30, 2014) and the 12-month trailing yield is 3.74% (as of Sep 30, 2014). It has nearly $5.2 billion in assets under management as of Oct 17, 2014.