These are unusual times for the U.S Real Estate Investment Trust (REIT) industry. After a remarkable run in the first four months of the year, the REIT industry has nosedived since May, and the volatility continues.
Prior to the recent uptrend in interest rates, the demand for these high-dividend-paying stocks remained sky high due to ultra-low interest rates. In 2012, the industry delivered a solid performance, beating the broader equity market for the 4th straight year. (Read: 3 Top Ranked ETFs for Earnings Season)
However, with the increasing yields on the U.S. Treasury 10-year note (2.72% as of July 5, 2013, compared with 1.68% at the end of April), investors are turning their focus away from REITs (primarily the mortgage REITs, commonly known as mREITs). Moreover, the rising interest-rate environment is a growing concern for REIT stocks as investors are concerned about the negative impact on book values and financing costs.
In May, on a total return basis, the FTSE NAREIT All REITs Index lost 6.56% and the FTSE NAREIT All Equity REITs Index lost 5.90% compared with the S&P 500 that gained 2.34%. (Read: 6 ETFs beating the market over the past year)
The June data looks disappointing as REITs were down 2.9%, according to the FTSE NAREIT U.S. REIT Index data. In the first half of the year, the total return from the FTSE NAREIT All Equity REITs Index was 5.8%, compared with the return of 13.2% from S&P 500.
Dividends Still Remain an Attraction
With the U.S. law requiring REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders, yield-seeking investors continue to prefer these stocks. This has aided the industry to stand out and gain a strong foothold over the past 15-20 years.
As of May 31, the dividend yield of the FTSE NAREIT All REITs Index was 4.19%, and the dividend yield of the FTSE NAREIT All Equity REITs Index was 3.35%. Moreover, the dividend yield of the FTSE NAREIT Mortgage REITs Index was 12.55% as of that date compared with 2.14% for the S&P 500. (Read: Buy these ETFs for brighter insurance sector outlook)
Accessibility to capital is a prime factor in the REIT Industry. After raising capital worth $51.3 billion in 2011 and a total of $73.3 billion in 2012, REITs raised $45.5 billion in the first six months of 2013.
During the latest downturn, REITs were able to acquire premium properties from highly leveraged investors at heavy discounts. Furthermore, REITs typically have a large unencumbered pool of assets, which could provide an additional avenue to raise cash during crisis. These assets, in turn, have provided the requisite wherewithal to the REIT industry to grow through strategic acquisitions over time.
For the sector as a whole, rising interest rates are a looming concern. High capital costs erode their profit level and hence trigger a fall in the dividend yield that the investors primarily look for while investing in REIT stocks.
Yet, though the macroeconomic issues and the political situation have been affecting the market, we believe that with the economic recovery gaining momentum, rents and occupancies would improve further.
Moving forward, limited supply of new construction coupled with the growing demand for premium properties bode well for the REITs, in particular for those that have assets in high barriers-to-entry markets.
Exploring the Sector through ETFs
Keeping that in mind, we believe this is the right time to explore the sector through ETFs so as to reap the benefits in a safer way amid the current volatility and the unusual market dynamics.
Therefore, with a low-cost investment choice, the prospects for return from dividend income and capital appreciation as well as focus on spreading out assets among various companies and reduce company specific risk, we have tracked the following REIT ETFs, which could be attractive picks:
Vanguard REIT ETF (VNQ - ETF report)
Launched on Sep 23, 2004, VNQ tracks the performance of MSCI US REIT Index. The fund consists of 126 stocks, which acquire office buildings, hotels, and other real property. The top three holdings are Simon Property Group Inc. (SPG), Public Storage (PSA) and HCP Inc. (HCP).
It charges a low 10 basis points in annual fees and has managed to attract about $18 billion in assets under management so far.
iShares U.S. Real Estate ETF (IYR - ETF report)
Launched on Jun 12, 2000, IYR follows the Dow Jones U.S. Real Estate Index.The fund comprises 96 stocks with top holdings including Simon Property Group Inc., American Tower Corporation (AMT) and Public Storage.
The fund’s expense ratio is 0.45% and the 12-month yield is 3.80%. It has about $4 billion in assets under management.
SPDR Dow Jones REIT ETF (RWR - ETF report)
Launched on Apr 23, 2001, RWR is an ETF that seeks investment results of the Dow Jones U.S. Select REIT Index. The fund consists of 86 stocks that have equity ownership and operate commercial real estate, with the top holdings being Simon Property Group Inc., Public Storage and HCP Inc.
The fund’s expense ratio is 0.25% and it pays a dividend yield of 3.03%. RWR has about $2.2 billion in assets under management as of Jun 28, 2013.
Schwab US REIT ETF (SCHH - ETF report)
This fund started on Jan 13, 2011 and tracks the total return of the Dow Jones U.S. Select REIT Index. The fund consists of 87 stocks that own and operate commercial real estates.
The top three holdings are Simon Property Group Inc., Public Storage and HCP Inc. It charges very low 7 basis points in fees, while the 12-month distribution yield is 2.30%.
SCHH currently has $553 million in assets under management.
First Trust S&P REIT Index Fund (FRI - ETF report)
Launched on May 8, 2007, FRI is an ETF that seeks investment results of the S&P United States REIT Index. The fund comprises 129 stocks with the top holdings being Simon Property Group Inc., Public Storage and HCP Inc.
The fund’s net expense ratio is 0.50% and the 12-month distribution rate is 2.07%. FRI has about $289 million in net assets under management.
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