Investors have been wary of real estate investment trusts and related exchange traded funds as the Federal Reserve cogitates on an interest rate hike. However, people should not passover the asset class altogether.
Investors can gain exposure to the broad REITs category through ETFs. For example, the Vanguard REIT ETF (NYSEArca: VNQ) and SPDR Dow Jones REIT ETF (NYSEArca: RWR) track a group of REITs, excluding mortgage REITs and non-real-estate specialty REITs. The iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR), though, takes a broader view and includes the more specialized REITs. [Sticking With a Popular REIT ETF]
REITs are securities that trade like a stock and invest in real estate directly through property ownership or mortgages. Consequently, revenue are mainly generated through rents or interest on mortgage loans. To qualify for special tax considerations, the asset also distributes the majority of income, about 90% of taxable profits, to investors as dividends.
Additionally, REITs provide diversification benefits as the asset shows a lower correlation to stocks and bonds. Over the past three decades, REITs’ rolling 36-month correlation to other stocks ranged from 0.89 to negative 0.16 – a value of 1 translates to perfect lock step while a negative value means the two assets moved in opposite directions. The correlation between REITs and Treasuries was 0.74 to negative 0.66 over the same period.
Nevertheless, some investors fear REITs will act negatively in rising interest rate environment. The high dividends in REITs are attractive in a low-rate environment but are less enticing once safer Treasuries show higher rates. [Don’t Overload REIT ETF Allocations]
Although REIT ETFs, such as VNQ and IYR, are seen as vulnerable to shifts in Fed policy, some market observers still see opportunity with the asset class.
“IYR has a great portfolio construction methodology for investors that want some diversified exposure to equity REITs. The dividend yield of 3.83% isn’t mind blowing, but it is higher than the yield on SCHH. Of course, investments in mREITs should help strengthen the dividend yield to make up for REITs like AMT that are priced based on expected future revenue growth combined with exceptional operational leverage,” according to a Seeking Alpha post.
Additionally, investors would also be taking a broad view on economic growth with REITs investments. Some investment experts argue that since commercial property has a larger presence in the U.S. economy than REITs do in the equities market, investors could benefit from a 5% to 10% allocation to REITs to bring their investments more in line with commercial property’s significance in the overall economy. [REIT ETFs Still Have a Place in an Investment Portfolio]
iShares Dow Jones US Real Estate Index Fund
