From Zacks: Even amid lingering rate issues and supply growth concerns in some asset categories, the real estate investment trust (REIT) industry managed to outpace the broader market in the first nine months of the year. This outperformance primarily suggests the growing appetite of investors for REIT stocks.
In fact, for the year through Sep 30, the FTSE/NAREIT All REIT Index managed to record a total return of 12.6% compared with the 7.8% increase logged by the S&P 500 Index. On the other hand, the yield on the 10-year Treasury note declined 0.7% over this time frame.
Further, a number of recent events are expected to significantly shape the REIT industry’s outlook. The most notable among these was the promotion of Equity REITs, together with other real estate companies, to their own headline sector under the Global Industry Classification Standard (GICS), following the close of trading on Sep 16.
This step is reflective of not only the growing importance of real estate in the global economy but is also likely to draw in billions into REITs as investment managers realign their portfolio strategies to bet more on this sector. So valuations are expected to get a push. (Read: ETF Strategies for Q4)
Second, the Federal Reserve decided to keep the rates unchanged in its September policy meeting. Obviously, the move relieved REIT investors for the time being because this debt-dependent industry will continue to benefit from the low-rate environment which keeps their borrowing costs down. On top of this, their dividend payout (which primarily makes them attractive) ends up being more lucrative than yields on fixed income and money market accounts in such an environment.
However, the outcome of the two-day meeting came with a grain of salt. The statement revealed Fed’s growing confidence in domestic economic growth. Yet, the central bank refrained from a rate hike call this time as it is waiting for “further evidence of continued progress toward its objectives.” Now, since a hike is almost ruled out in the next Fed meeting which is slated in an uncertain period right before the presidential election, a liftoff in December seems to be pretty much on the table.
Nevertheless, the supplementary summary of economic projections this time revealed a pull down in expectations of rate increases in the years ahead. So, even when rates rise, the pace is likely to be modest. REITs are expected to have time to adjust their business accordingly. (Read: 6 Bond ETFs to Play Higher Rates)
In addition to the above issues, the performance of REITs is largely determined by the demand-supply dynamics in individual asset categories. Therefore, as long as rate hikes are backed by an improving economy, REIT investors need not worry much. This is because when economic activity gathers steam, demand for space automatically grows.
Dividends Still Standing Tall
Moreover, dividends are by far the biggest enticement to invest in REIT stocks, especially for income-seeking investors. And encouragingly, as of Aug 31, the dividend yield of the FTSE NAREIT All REITs Index was 3.87%, which handily outpaced the 2.13% dividend yield offered by the S&P 500 as of that date. Over long periods too, REITs have outperformed the broader indexes with respect to dividend yields.
Notably, the U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders. This unique feature made the industry stand out and gain a solid footing over the past 15–20 years. (Read: How Retirement Saving Rules are Making ETFs More Attractive)
Further, in recent years, REITs have been proactive in the capital market. They have drawn leverage from the low rate environment and improved their financials. In 2015, a total of $59.3 billion in public capital was raised by stock exchange-listed REITs and in 2016 through Aug 31, REITs collected $52.3 billion in capital offerings.
Moreover, reforms to the Foreign Investment in Real Property Tax Act (FIRPTA) are expected to offer easy access to capital from foreign investors for publicly traded REITs and commercial real estate.
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 safer way. Considering the return prospects from dividend income and capital appreciation, we have tracked the following REIT ETFs that could be worth considering:
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 150 stocks, which acquire office buildings, hotels and other real estate property. The top three holdings are Simon Property Group Inc. (SPG), Public Storage (PSA) and Prologis, Inc. (PLD). It charges 12 basis points (bps) in fees. VNQ managed to attract around $32.9 billion in assets under management as of Oct 14, 2016.
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 126 stocks with top holdings including Simon Property Group Inc., American Tower Corporation (AMT) and Public Storage. The fund charges 44 bps in fees (as on Jun 30, 2016) and its 30-day SEC yield is 3.41% (as of Sep 30, 2016). As of Oct 14, 2016, it had around $4.1 billion in assets under management.
Functioning since 2001, RWR seeks investment results of the Dow Jones U.S. Select REIT Index. The fund consists of 102 stocks that have equity ownership and operate commercial real estates, with the top holdings being Simon Property Group Inc., Public Storage and Prologis. The fund charges 25 bps in fees while the 30-day SEC yield is 3.37% (as of Oct 13, 2016). Its assets under management were $3.5 billion as of Oct 14, 2016.
This fund debuted in 2011 and tracks the total return of the Dow Jones U.S. Select REIT Index. The fund consists of 108 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 3.20% (as of Oct 14, 2016). Further, SCHH had $2.7 billion in assets under management as of Oct 14, 2016.
Launched in May 2007, FRI is an ETF that seeks investment results of the S&P United States REIT Index. The fund comprises 157 stocks with the top holdings being Simon Property Group Inc., Public Storage and Prologis. The fund charges 48 bps in fees and had a 30-day SEC yield (as of Sep 30, 2016) of 3.38%. FRI had about $332.3 million in assets under management as of Oct 14, 2016.
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., Public Storage and Prologis. The fund charges 34 bps in fees while the 30-day SEC yield is 2.89% (as of Sep 30, 2016). Its assets under management were $3.9 billion as of Oct 14, 2016.
This article is brought to you courtesy of Zacks Research.