The U.S. Real Estate Investment Trust (REIT) sector has been popular mostly amongst small investors due to its higher yields than other investments.
U.S. REIT investments have been pretty solid in 2013, buoyed by strong demand for these types of securities. However, after a remarkable run in the first four months of the year, the REIT industry has nosedived since May, and the volatility continues. The June-ending quarterly returns for FTSE NAREIT All REIT Index was -3.39%, underscoring the sluggish performance of the space in the time frame.
Recent rumblings from the Federal Reserve and speculation over their bond buying program have rattled the U.S. REIT market. That is because REITs are very sensitive to changes in interest rates, and the recent talk from the Fed has certainly influenced Treasury bond yields, and thus REIT investments as well (read Medium Term Treasury Bond ETF Investing 101).
In recent news
Due to the increasing yields on the U.S. Treasury 10-year note (2.5% as of mid July 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, which tend to be levered).
Moreover, a rising interest rate environment is a growing concern for the REIT stocks as investors are concerned about the negative impact on the book values and financing costs.
In a recent video conference on REIT.com, Ben Butcher, president and CEO of STAG Industrial, Inc. commented that “The industrial economy tends to follow the general economy, so with the gradual improvement in the general economy, we’re seeing an improvement in the industrial economy and leasing.” This suggests that there is definitely room to run in the space, and that fundamentals are strong for the REIT segment.
Can this trend continue?
Analysts are of the opinion that further rise in rates would force REITs to pay higher amounts to borrow money which in turn would impact its yields and distract investors. On the positive side, analysts suggest that the REIT sector will have returns varying between 11%–15% including dividends this year.
With 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 few years.
Investor sentiments were seen on the greener side for multifamily (3.5%) and self-storage (2.34%), meaning these segments could lead the way. Additionally, analysts expect a rise in demand for apartments if long-term rates increase, which would weaken new home purchases, but be good news for apartment REIT operators (See 2 Forgotten REIT ETFs to Buy Now).
Recent REIT results
Almost all the REIT funds posted negative results in the second quarter. However, the segment which was worst hit was Mortgage REITs. MREIT, which uses short-term debt to buy long-term mortgage backed stocks, crashed 18%. "A lot of the concern in the quarter was for the book values" of mortgage REITs, said Jason Arnold, an analyst at RBC Capital Markets (See Mortgage REIT ETFs: Is the Plunge Over?).
The sectors which reported negative returns this quarter include Healthcare REITs (-4.4%), Strip Mall Companies (-3.6%) and Office REITs (-0.91%).
REIT ETFs to focus on
The space has come back a bit to start this quarter though, as hopes for a lengthier stimulus program have combined with a desire for high yields to push the space back up. In particular, we like the following three REIT ETFs as solid picks in this type of environment to lead the way higher if REITs continue to march back on track:
Power Shares KBW Premium Yield Equity (KBWY)
Launched in Dec 2010, KBWY follows the KBW Premium Yield Equity REIT Index. With its main focus on small and mid cap REIT securities, the fund seeks to provide exposure to a small basket of 34 stocks. The top ten holdings have a share of 38.10% in the fund while the ETF has an asset base of $98.1 million and charges 35bps in fees.
The fund trades more than 177,000 shares a day and generates a decent yield of 4.63%. The ETF has generated good returns of 19.8% in the year-to-date period and is relatively liquid (also read Mortgage REIT ETFs: Is the Plunge Over?).
Vanguard REIT Index ETF (VNQ)
Launched in Sep 2004, VNQ tracks the MSCI US REIT Index. With its main focus on large and mid cap stocks, the fund seeks to provide exposure to a large basket of 126 stocks. The top ten holdings contribute 42.6% to the fund. The product has a huge AUM of $17.99 billion and charges a very low 10bps in fees.
The fund trades in more than 2.4 million shares a day and provides a good yield of 3.56%. The product has given returns of 10.6% for the YTD period.
SPDR Dow Jones REIT ETF (RWR)
Launched in Apr 2001, RWR tracks the Dow Jones U.S. Select REIT Index. The fund has a major focus on large cap equities and holds 86 stocks in the basket. The top ten holdings contribute 48.47% in the fund. The product has a large asset base of $2.2 billion and charges 25bps in fees.
The fund has a daily trading volume of 143,000 shares a day and has given a yield of 2.98%. RWR has seen a solid return of 9.7% for the YTD period.
The Bottom Line
Macroeconomic issues and the political situation have been affecting the market, but it is believed that with the economic recovery gaining momentum, rents and occupancies would improve further.
Moving forward, limited supply of new construction along with a growing demand for premium properties bodes well for the REITs, in particular for those that have assets in high barriers-to-entry markets, suggesting that the aforementioned funds could be solid choices for those seeking lower risk ways to access the space.
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