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The market anticipated a flight of capital from interest rate sensitive sectors like real estate investment trust (REIT) with the Federal Reserve raising the benchmark rate on Jun 14 by a quarter of a point, the second time in 2017.

But things don’t appear too bad for REITs. This is because, the magnitude of the hike was in line with expectations. On top of that, the yield on the benchmark 10-year Treasury notes, which have an inversely proportional relation with prices, moved lower amid weak inflation numbers for May and the central bank’s cut in inflation projectionsfor the year.

So REITs are back in the spotlight. They are often treated as bonds for their high dividends and therefore treasury yields end up playing a significant role in their price movement. Therefore, when treasury yields decline, REIT stocks look attractive. (Read: Amazon's Foray Into Grocery to Hurt/Help These Stocks & ETFs)

In fact, on Jun 14, the FTSE/NAREIT All REITs Index managed to return0.09%, compared with the 0.10% decline for the S&P 500 Index. On the other hand, the yieldon the 10-year Treasury note declined to 2.15% on Jun 14 from 2.21% the previous day.

What’s Next?

Aside from the rate hike and treasury yields issues, the performance of REITs depends on other factors. Specifically, with REITs catering to a wide range of real estates and each asset category having its own demand-supply dynamics, performance of REITs varies widely.

In the first five months of 2017 the overall returns from the REIT industry fell short of the broader market amid uncertainty and restrained trading activity (FTSE/NAREIT All REITs Index registered a total return of 3.34%, which could not match the S&P 500’s stellar gain of 8.7%) and sectors like retail REITs felt the heat with dwindling traffic and store closures amid aggressive growth in online sales. However, a number of asset categories showed fundamental strength and the REITs catering to those asset classes reaped benefits.

Among these are data center REITs that posted total returnsof 23.6% in the first five months of 2017, with growth in cloud computing, Internet of Things and big data. Moreover, infrastructure REITs gained 21.9% and Specialty REITs delivered returns of 10.4%, handily outpacing the broader market. Industrial REITs also benefited from the e-commerce boom and returned 7.8% till May end. (Read: Long-Term Treasury ETFs in Play Post Fed Decision)

But retail REITs are not way behind and are avoiding heavy dependence on apparels and accessories. They are making every effort to win back footfall to their malls by transforming their boring shopping hubs into swanky entertainment zones, expanding the dining options, opening up movie theaters and offering recreational facilities.

Also, several REITs are no longer restricting themselves to only one asset category and exploring options like mixed-use developments which have gained popularity for their solid neighborhood character, greater housing variety and density. Such developments lower the distance between housing, workplaces, retail businesses, and other amenities and destinations. Hence, such development enable the companies to grab the attention of people, who prefer to live, work and play in the same area – a trend that drove development in several other cities in the U.S. (Read: ETF Winner and Loser from a Flattening Yield Curve)

Therefore, preferring the industry or ignoring it just based on rate and treasury yield movements won’t be prudent. Investors need to first study the fundamentals of the underlying asset category before making any investment.

Dividends Standing Tall

Dividends are by far the biggest enticement in REIT stocks, and income-seeking investors continue to prefer them. This is because, as of May 31, 2017, the dividend yield of the FTSE NAREIT All REITs Index was 4.16%, which handily outpaced the 1.99% dividend yield offered by the S&P 500.

Among the REIT market components, the FTSE NAREIT All Equity REIT Index enjoyed a dividend yield of 3.87% while the FTSE NAREIT Mortgage REITs Index had a dividend yield of 9.70%. Over long periods too, REITs have outperformed the broader indexes with respect to dividend yields.

U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders. This unique feature helped the industry stand out and gain a solid footing in the past 15–20 years.

Capital Access

Further, in recent years, REITs managed their balance sheets well and focused on lowering debt and extending maturities. Also, REITs have indeed been proactive in the capital market, with the stock exchange-listed REITs collecting $69.6 billion in capital offerings in 2016. Moreover, $23.11 billion of capital raisedin the first quarter of 2017 was more than in any quarter since the second quarter of 2014. This denotes investors’ growing confidence in the industry. Further, as of May 31, 2017, REITs have raisednearly $37.0 billion in capital.
 

Exploring the Sector Through ETFs

We believe that this is the right time to explore the sector through Exchange Traded Funds (ETFs), so as to reap the benefits in a less risky way. Considering the return prospects from dividend income and capital appreciation, we have tracked the following REIT ETFs that could be worth considering:

Vanguard REIT ETF (VNQ - Free Report)

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 157 stocks, which acquire office buildings, hotels and other real estate property. The top three holdings are Simon Property Group Inc. (SPG), Equinix, Inc. (EQIX) and Public Storage (PSA). It charges 12 basis points (bps) in fees. VNQ managed to attract around $34.1 billion in assets under management as of Jun 14, 2017.

iShares U.S. Real Estate ETF(IYR - Free Report)

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 125 stocks with the top holdings including American Tower Corporation (AMT), Simon Property Group Inc. and Crown Castle International Corp. (CCI). The fund charges 43 bps in fees (as on Mar 31, 2017) and its 30-day SEC yield is 3.43% (as of May 31, 2017). As of Jun 14, 2017, it had around $4.3 billion in assets under management.

SPDR Dow Jones REIT ETF(RWR - Free Report)

Functioning since 2001, RWR seeks investment results of the Dow Jones U.S. Select REIT Index. The fund consists of 106 stocks that have equity ownership and operate commercial real estates, with the top holdings being Simon Property Group Inc., Public Storage and Prologis, Inc. (PLD). The fund charges 25 bps in fees while the 30-day SEC yield is 3.41% (as of Jun 13, 2017). Its assets under management were $3.0 billion as of Jun 14, 2017.

Schwab US REIT ETF(SCHH - Free Report)

This fund debuted in 2011 and tracks the total return of the Dow Jones U.S. Select REIT Index. The fund consists of 131 stocks that own and operate commercial real estates. The top three holdings are Simon Property Group Inc., Public Storage and Prologis. It charges 7 bps in fees while the 30-day SEC yield is 3.29% (as of Jun 14, 2017). Further, SCHH had $3.4 billion in assets under management as of Jun 14, 2017.

First Trust S&P REIT Index Fund(FRI - Free Report)

Launched in May 2007, FRI is an ETF that seeks investment results of the S&P United States REIT Index. The fund comprises 158 stocks with the top holdings being Simon Property Group Inc., Public Storage and Prologis. The fund charges 49 bps in fees and had a 30-day SEC yield (as of May 31, 2017) of 3.71%. FRI had about $211.8 million in assets under management as of Jun 14, 2017.

iShares Cohen & Steers REIT ETF(ICF - Free Report)

Incepted in 2001, this fund follows the Cohen & Steers Realty Majors Index. The fund comprises 30 stocks with the top holdings being Simon Property Group Inc., Equinix, Inc. and Public Storage. The fund charges 34 bps in fees (as of Mar 31, 2017), while the 30-day SEC yield is 3.03% (as of May 31, 2017). Its assets under management were $3.3 billion as of Jun 14, 2017.

 

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