VNQ Vanguard Real Estate ETF

After a bull run in the first four months of the year, the U.S Real Estate Investment Trust (REIT) industry had nosedived after the onset of “taper talk” which pushed up interest rates sharply. Since then, the downside risk in the sector has been acute with S&P/TSX Capped Real Estate Index trimming about 5.10% in the last six months.
 
However, the trend recently saw a reversal after the Federal Reserve’s surprising ‘No Taper’ decision that ended four months of market speculation (Read: REIT ETFs Rise as Treasury Yields Finally Tumble).
 
The Positives
 
Prior to the recent uptrend in interest rates, these high-dividend paying stocks were in great demand due to ultra-low interest rates. After the no-taper  shocker,  this interest rate sensitive REIT sector sending it northward. Since then, the sector has been outperforming the broader market.
 
 The yield on the benchmark U.S. Treasury 10-year note has declined to 2.63% as of October 4, 2013 from 2.76% as on September 19, 2013.
Investors are once again turning their focus towards this corner of the investing world in view of the fact that yield on 10-year Treasury note is still lower than the average rate of 6.4% during 1912 to 2013, even after the spike in interest rates in recent times should soothe investors’ nerves (Read: Mortgage REIT ETFs: Is The Plunge Over?).
 
Dividends still remain an attraction in the sector. 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. A decline in borrowing costs normally supports REITs dividend profile since the policy is in favor of servicing debt and accessing capital. This favorable business environment helps REITs boost their dividends. Recovering housing and labor markets will also act as major tailwinds.
 
Market Impact

In such a scenario, investors might want to pay close attention to the REIT ETF market in the near term. Below, we briefly highlight the some funds in the space which could be great short-term picks. Vanguard REIT ETF (VNQ), iShares U.S. Real Estate ETF (IYR), SPDR Dow Jones REIT ETF (RWR), Schwab U.S. REIT ETF (SCHH), and First Trust S&P REIT Index Fund (FRI) gained a respective 2.24%, 2.44%, 2.28%, 2.0% and 2.1% in the last month (as of September 25) while SPDR S&P 500 (SPY) added 1.94% during the time frame (see more ETFs in the Zacks ETF Center).
 
VNQ is an extremely popular choice in the space with more than$17.0 billion in assets, but funds like IYR ($4.5 billion) and RWR ($2.0 billion) also attract sufficient investments. Among these, SCHH and FRI are slightly overlooked options with around $500 million and 150 million of AUM respectively.
 
Among the five, SCHH is the cheapest charging only 7 basis points in annual fees while VNQ and RWR cost 10 bps and 25 bps respectively.  However, IYR and FRI are pricier funds charging 48 and 50 basis points individually, slightly higher than the average expenses charged by their other REIT cousins.  

Investors should note that all funds barring SCHH (1.9% as of Sep 25) currently have a dividend yield more than 3%. The funds have more-or-less 50% investment in large caps giving a leeway for decent capital appreciation since the remaining 50% of the assets are invested in mid-to-small-caps which are known for their high return-high risk criteria.
 
Road Ahead
 
Given that REITs were highly beaten down since late May, this could be a good entry point to the sector. Moreover, with taper talk coming to rest as of now, REITs are likely to surge higher in the coming weeks.
Having said all, the duration of this trend is still unclear with some macro concerns even in a positive scenario. Reacting to Fed’s surprise announcement last month, investors are now dithered about the future of QE, a possible government shutdown and the debt ceiling debate.
 
 
A trimmed outlook for 2013 and 2014 US GDP has also added to the woes. All these had a slightly negative impact on the REIT sector alongwith the broader market. Hence, after shooting up on September 19, the REIT ETFs began to slide (read: Bet Against Real Estate with These Short REIT ETFs).

Also one word of caution is that sooner or later, at least a soft taper will be put into action. Till then, income seeking investors can reap the return from REIT investing thanks to the sector’s low valuation. On a greener side, funds with higher exposure in retail, residential and healthcare REITs will likely be less ruffled amid rising rates compared to the funds with increased coverage in mREITs. 

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FT-SP REIT IDX (FRI): ETF Research Reports
 
ISHARS-US REAL (IYR): ETF Research Reports
 
SPDR-DJ W REIT (RWR): ETF Research Reports
 
SCHWAB-US REIT (SCHH): ETF Research Reports
 
VIPERS-REIT (VNQ): ETF Research Reports
 
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