Eric Dutram: The U.S. Real Estate Investment Trust (REIT) industry has managed to surge so far in 2012, driven by strengthening fundamentals for commercial real estate and an improving outlook for the U.S. economy despite some recent doubts. The uptrend further suggests that economic growth was broadening across sectors and it is indicating to some that a higher probability of a firmer foundation for future economic expansion (Real Estate ETFs: Unexpected Safe Haven).
Equity prices moved northwards as geopolitical noise remained relatively benign with a controlled restructuring of Greek debt and additional liquidity provided to European banks, thereby reducing a potential threat to the global financial system.
Meanwhile closer to home, the Fed maintained a low rate of interest and even promised to keep it there through late 2014 to sustain the economic recovery. With expected GDP growth of around 2% in 2012, positive vibes were emanating from the overall economic landscape. Employment data was also encouraging, with an average monthly gain of 226,000 for the first quarter of the year.
However, with escalation of the European debt crisis and emerging signs of economic weakness all over the world, average employment growth dropped to a mere 75,000 per month during the second quarter of 2012 (Three Resilient European ETFs Still Going Strong). This held back the growth momentum to some extent, as speculation of a worsening sovereign debt crisis in Europe weighed on investors.
Nevertheless, the U.S. REIT industry outperformed the broader equity market in the first half of 2012. The FTSE NAREIT All Equity REIT Index reported total returns of 16.11% as of July 2, 2012 vs. 13.28% and 8.58% for the NASDAQ Composite and the S&P 500 Index, respectively.
A combination of factors has helped the listed REIT sector to stand out and gain critical mass over the past 15 to 20 years, the most notable among them being a healthy dividend payout. Total returns of 16.11% for the FTSE NAREIT All Equity REIT Index in the first half of 2012 included a share price return of 14.12%.
High Yield Destination
Investors looking for high dividend yields have historically favored the REIT sector. Solid dividend payouts are arguably the biggest enticement for REIT investors as U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders. The dividend yield for the FTSE NAREIT All Equity REIT Index as of July 2, 2012 was 3.25%, compared to 1.58% for the 10-year U.S. Treasury Note. (Do ex-Financial Funds Make Safer Dividend ETFs?)
Moreover, according to data from NAREIT, the debt ratio of equity REITs (total industry debt as a percentage of its total debt and equity market capitalization) as of December 31, 2011 was 38.6% — significantly lower than 51% at the end of the second quarter 2008, which was prior to the Lehman Brothers collapse and the start of the ‘Great Recession.’
However, given the positive note in investor sentiment, a number of factors thwart the otherwise positive market scenario. As it is a presidential election year, chances are high that the U.S. policymakers will refrain from making any radical changes on key issues.
With political uncertainty persisting until at least the elections are over, investors might play a ‘wait and see’ game before committing on better investment opportunities. This could, in turn, put a ceiling on equity returns in the latter half of 2012.
Furthermore, the strategic move to focus on austerity measures among European countries could impede regional economic growth, leading to a dearth of investor confidence in the European financial and fiscal system.
In addition, economic growth in emerging markets, particularly the BRIC countries, is expected to moderate from recent years, driven by a relative weakness in the developed world and related uncertainties in the global business climate. All these factors could cumulatively lead to an equity market headwind in the remainder of 2012.
In a nutshell, the long-term prospect of the REIT industry looks favorable with a mild cautionary note. Investors who want play in this slice of the market in the ETF form have the following options available, any of which could be interesting ways to target this increasingly important slice of the market:
Vanguard REIT ETF (NYSEARCA:VNQ)
VNQ is one of the most popular ETFs in the real estate space (Is ROOF a Better Real Estate ETF?). It trades with the volume level of more than one million shares a day and with an asset base of $27.3 billion. It provides exposure to a basket of 111 stocks.
The fund appears to be moderately diversified as 46.2% of asset base is invested in the top 10 holdings. Among individual holdings, Simon Property Group Inc takes the top spot with an asset investment of 11% while Public Storage and Equity Residential occupy the other two spots with 5% and 4.4% of the assets, respectively.
For this exposure, the fund charges an expense ratio of 10 basis points annually. The fund has delivered a return of 11.8% over a period of one year and has a solid yield of 3.24%.
Dow Jones U.S. Real Estate Index Fund (NYSEARCA:IYR)
IYR is another popular ETF in the real estate space. This ETF provides liquidity to the investors trading with the volume level of more than three million shares a day and an asset base of $3.87 billion.
The fund manages a basket of 85 real estate companies with 41.8% of asset base invested in the top 10 holdings. Among individual companies, Simon Property Group takes the top spot with a share of 9.07% while American Tower Corp and Public Storage occupy the second and third positions with an asset investment of 5.34% and 3.96%, respectively.
Among sector holdings, Specialty REIT, Retail REIT and Industrial REIT take the major chunk of the asset base collectively having a share of 68.03%.
For this the fund charges an expense ratio of 47 basis points, putting it in a decent position in terms of total costs. Over a period of one year, the fund delivered a return of 10.29% with a dividend yield of 3.39%.
Cohen & Steers Realty Majors Index Fund (NYSEARCA:ICF)
ICF tracks the Cohen & Steers Realty Majors Index, offering exposure to about 31 firms in total while paying out 2.7% to investors in 30 Day SEC Yield terms. Expenses and volume are in the middle, as costs come in at 35 basis points and volume is at 0.3 million shares a day.
Among individual companies, Simon Property Group takes the top spot with a share of 7.9% while Public Storage and HCP Inc take the second and third positions with respective shares of 7.04% and 6.54%. Large caps still dominate from a cap perspective, while blend and value take the bulk of assets from a style perspective.
Over a period of one year, the fund delivered a return of 12%.
Dow Jones REIT ETF (NYSEARCA:RWR)
This ETF tracks the Wilshire REIT Index which follows companies that operate commercial real estate properties across the country (Time for a Commercial Real Estate ETF?). The product utilizes a float-adjusted market capitalization technique and charges investors 25 basis points a year in fees for its services.
In terms of yield, the product pays out about 3.01% in 30 Day SEC yield terms while trading volumes are quite robust. With average volume of over 1.5 million shares, the product has tight bid ask spreads as well, giving it low overall total costs.
Overall, the product holds 85 securities in total, including an 11.6% weighting to Simon Property Group while Public Storage and HCP Inc get shares of 5.1% and 4.8%, respectively.
Over a period of one year, the fund delivered a return of 13.05%.
iShares FTSE NAREIT Mortgage REIT ETF (NYSEARCA:REM)
In another real estate sector play, investors can consider REM. The fund’s dividend will be extremely tough to beat as the product currently has a 30 Day SEC Yield of 12.2%. The fund trades at the volume level of 815,800 shares a day and with an asset base of $722.4 million. The fund charges an expense ratio of 48 basis points a year.
However, the product provides a very narrow exposure profile to real estate stocks holding a basket of 29 companies in total. Also, in this holding of 29 stocks, 74.15% of asset base goes to the top 10 holdings suggesting a high level of company specific risk (Three ETFs With Incredible Diversification).
Among individual holdings, Annaly Capital Management and American Capital Agency Corp collectively account for 38.2% while among other companies, the fund does not invest more than 5.56%. For this, the fund charges an expense ratio of 48 basis points annually.
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