REIT ETFs Look Expensive After Big Run: Strategist

July 26th at 1:24pm by John Spence

Exchange traded funds that invest in real estate investment trusts have roughly doubled the return of the S&P 500 so far this year with the rally fueled in part on investors’ hunger for income.

“With yields low and likely to stay that way for the foreseeable future, everyone is searching for income wherever they can find it,” says Russ Koesterich, iShares global chief investment strategist at ETF manager BlackRock. “One of the biggest beneficiaries of this ‘stretch-for-yield’ has been the REIT industry.” [Be Careful When Reaching for Yield with ETFs]

REITs are publicly traded companies that give investors exposure to the commercial real estate market. The companies are required to pay out most of their net income to shareholders in the form of dividends. The asset class fell sharply in the credit crunch as many REITS were hit by the economic slowdown and too much leverage.

The $4 billion iShares Dow Jones U.S. Real Estate Index Fund (NYSEArca: IYR) is up 13% year to date, compared with a 7.5% gain for the S&P 500, according to Morningstar. Other large offerings covering the sector include Vanguard REIT ETF (NYSEArca: VNQ) and SPDR Dow Jones REIT ETF (NYSEArca: RWR).

“Since its 2009 lows, the S&P REIT industry has gained roughly 220%, more than twice the gain for the broader U.S. equity market,” Koesterich wrote at the iShares blog. “This outperformance has continued in recent months.”

Yet he said REITs look expensive after the rally judging by price-to-book ratios versus the broader market and other financial companies.

“What does appear to be driving the current premium is the search for income at any price. As investors stretch for yield, REITs are a natural beneficiary,” the strategist noted.

The iShares Dow Jones U.S. Real Estate had a 12-month yield of 3.47% as of June 30, according to BlackRock. Yet that figure is “well below” the 10-year average of 4.75%, Koesterich said, adding that REITs’ yields compared to the 10-year Treasury note do not look particularly attractive. Yields on 10-year notes were trading right around 3% on Tuesday.

“Today, investors appear to be paying too much for too little income in a number of asset classes, including REITs,” Koesterich concluded.

iShares Dow Jones U.S. Real Estate

Chart source: StockCharts.com.

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