Despite fears of a rising rate environment, interest rates remain stubbornly low. Investors who believe rates will remain subdued going into the new year can utilize a broad real estate investment trust exchange traded fund to generate some extra income.
The Vanguard REIT ETF (NYSEArca: VNQ), with a 3.13% 12-month yield and a 0.10% expense ratio, provides a cheap and decent way to track the broad REITs market.
“Right now, Morningstar’s equity analysts believe that the U.S. REIT sector as a whole is slightly overvalued,” according to Morningstar analyst Robert Goldsborough. “However, our analysts also see pockets of opportunity in certain areas of the REIT landscape, including health care, retail, and cell tower properties.”
For instance, VNQ includes a 13.5% weight toward health care REITs and 25.9% in retail REITs.
Along with its diversified sub-sector exposure, VNQ includes a relatively spread out market capitalizations, including 43.4% large-caps, 34.3% mid-caps, 19.0% small-caps and 3.3% micro-caps.
REITs provide a liquid alternative to owning physical commercial real estate properties. REITs investments also share similar attributes with stocks and bonds. Since REITs are required to distribute at least 90% of their income from rent payments to investors, these real estate investments can generate attractive yields.
Additionally, S&P Dow Jones Indices and MSCI (NYSE: MSCI), two of the largest providers of benchmarks for exchange traded funds, recently announced that real estate will become the eleventh Global Industry Classification Standard (GICS) sector, breaking off REITs from the broader financials sector. [Sector Classification Change Could Boost REITs ETFs]
Potential investors should not mistake REITs as an alternative to traditional fixed-income assets like Treasuries. The REITs asset class has been 41% more volatile than the S&P 500 over the past three years and 5.5 times more volatile than the U.S. bond market.
“Potential near-term risks include slower-than-projected growth, setbacks in the U.S. economy, and rising interest rates,” Goldsborough added.
Rising rates raise REITs’ debt financing costs. However, a flat interest rate outlook would benefit REITs in an expanding economic environment as rising rents and property prices would support the asset class. [REIT ETFs for Income Generation and Diversification]
Vanguard REIT ETF
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.