Real Estate ETFs Might Not Lag Much Longer

Ten of the 11 S&P 500 sectors are in the green so far this year. This article, to paraphrase the classic rock satire “This is Spinal Tap,” is about the one that goes to 11. 

We're talking about the real estate investment trust (REIT) sector of the S&P 500, represented through the $6 billion Real Estate Select Sector SPDR Fund (XLRE) ETF.  

XLRE debuted in 2015 when the S&P index committee decided to spin off REITs from within the financial sector. During the past five years, the fund has gained only 17% including dividends, which are a feature of this yield-oriented sector. That total return since this time in 2019 also ranks at the bottom of the sector performance tables, half that of utilities, the next poorest performer. 

XLRE YTD Flows

REITs are a bit different from other stock sectors because the real estate business doesn't fit smoothly into traditional earnings analysis. They are typically valued based upon a non-traditional measure known as funds from operations or FFO, the sort of earnings per share for REITs. Investors must be familiar with this or else risk mistakenly incorrectly evaluating a fund.

As for XLRE, it may in part be a victim of its own success. That sounds strange for an ETF that has dragged return-wise versus other sectors. However, the lower yielding but higher growth potential segments of the public REIT market had a period where they rose sharply in value, thanks to the role they played in housing data centers and cell towers.  

That was compounded by the severe, lasting impact of the pandemic on other, higher-yielding REIT sub-sectors, such as shopping malls and residential REITs, which are naturally impacted by the 11 Fed rate increases. XLRE owns 33 stocks, though only 10 names account for 52% of assets.  

REIT ETFs Beyond XLRE

REITs have two clear potential advantages looking forward, which might cause real estate ETFs to garner more interest in the years ahead. First, XLRE currently yields 3.5%. That might sound like much in an era of 5% T-bill rates, but it is the highest-yielding S&P 500 sector. In fact, its yield is more than double that of six of the 11 sectors.  

And with Baby Boomers retiring in massive numbers, that higher income plus return potential of the underlying stocks makes REITs a strong consideration. That they are possibly undervalued after years of lagging performance could add to the attraction.  

XLRE is not the only house in the REIT ETF neighborhood. The $116 million Invesco S&P 500 Equal Weight Real Estate ETF (RSP) takes those same stocks in XLRE and owns them in roughly the same amounts. That hurt RSPR versus XLRE during the pandemic crash in early 2020, but since the March 23, 2020, market bottom, RSPR has outperformed its capitalization-weighted counterpart by 20%.  

This REIT ETF Yields 8%

Those screening for super-high yielders have several choices, including the $210 million Global X SuperDividend REIT ETF (SRET) and its whopper of a yield, which currently sits at just over 8%. SRET needs to dive much deeper down in the market cap range to find those higher yielders, with a weighted average company size of $2.6 billion, less than 10% the average size of an XLRE holding.  

Real Estate is probably still more familiar to many investors in its live form, through a house, a shopping center, office building or storage unit. But REITs are a very diverse and viable sector for ETF investors, and while past underperformance does not mean it will reverse itself, it helps value-oriented investors feel a sense of the “buy low/sell high” aspect of investing at times like these.