This has been an interesting year for investors, as stocks and bonds rally pretty much at the same time, making the job of finding uncorrelated—or low-correlated—returns a little tricky.
This is where a segment like real estate investment trusts (REITs) comes in. REITs not only offer returns that have low correlation to traditional stocks and bonds, but so far this year, they have delivered solid outperformance relative to the broader market.
As a sample of that performance, consider the returns of the biggest real estate ETF, the $33 billion Vanguard Real Estate ETF (VNQ), and of a smart beta take on the segment, the U.S. Diversified Real Estate ETF (PPTY), relative to the SPDR S&P 500 ETF Trust (SPY) year to date:
Chart courtesy of StockCharts.com
When you buy REITs, you’re essentially buying stocks of companies that own, manage and lease real estate properties. Most of these companies are in commercial real estate, and they focus on one type of property, say, retail, health care facilities, hotels, communications, etc. If you buy a REIT ETF, you’re getting a portfolio of several of these companies.
REITs are often touted for hefty dividends they shell out—payouts that this year are outsizing yields in government and corporate investment grade bonds, according to Vident Financial data. That income stemming from property rent is a key driver of REIT returns.
Why REITs ETFs Work
Some argue that real estate shouldn’t be considered an asset class on its own despite its low correlation to stocks and bonds. Real estate is, however, its own sector in the S&P 500 (represented in the ETF universe by the Real Estate Select Sector SPDR Fund (XLRE)).
What’s important is that REITs have some key characteristics that may benefit a portfolio beyond performance:
- Portfolio diversification: REITs have low correlation to stocks and bonds due to their driver of returns
- Hedge against inflation: inflation typically leads to higher rents, which is good for REITs
- Steady income: REITs pass the majority of their income to investors as dividends
- Growth potential: REITs do well when the economy is growing, but can also do well in slow growth times due to stable income
If the broad investment case for owning REITs is easy to grasp, the devil is in the details. Evaluating REITs and the ETFs that own them is no small task.
To start, REITs come in different flavors when it comes to property types. There are commercial REITs accessing all sorts of different commercial properties. There are also residential REITs, and there are mortgage REITs.
Each of these REITs can perform differently in different market environments, much like S&P 500 sectors. You could think of them as cyclical or defensive. Some do well during economic growth times, others may weather a slowdown much better.
Beyond type, there’s also the issue of location. Where is the property located? A bad location can impact how well REITs perform. Another consideration is the debt levels of these trusts, particularly when in a rising rate environment when the cost of borrowing money goes up.
There’s plenty that goes into doing due diligence in this space.
The good news is that if you’re looking to access real estate, there are 45 ETFs focused on this sector, some of which are big, liquid strategies such as the $33 billion VNQ and the $5.4 billion Schwab U.S. REIT ETF (SCHH).
The bad news is that no two are alike. There are broad vanilla funds. There are smart beta takes on the segment such as the FlexShares Global Quality Real Estate Index Fund (GQRE), which screens securities by factors such as momentum, quality and value; the Global X SuperDividend REIT ETF (SRET), which focuses on high-yielding, low volatility REITs; and the U.S. Diversified Real Estate ETF (PPTY), which selects and weights securities based on fundamentals. There are many other ways to slice and dice real estate.
You’ll have to do some homework to find the best fit for you. And here’s where we can help.
On Tuesday, June 11, we’ll be talking about the best way to evaluate REITs and real estate ETFs, exploring what you should expect to get from this type of investment.
Please join me, Jerry Bower, Fred Stoops and Kevin Davis from the Vident Financial team behind PPTY; as well as Andrew Alden, head of quantitative research at WeatherStorm Capital, for a conversation on how to go about investing in the real estate segment.
We’ll get started at 2:00 pm ET on Tuesday, June 11, and CE credits are available. Bring all of your questions. We look forward to having you join us.
You can register here.
Contact Cinthia Murphy at [email protected]