Real estate investment trusts (REITs) and the corresponding exchange funds, including the largest, the Vanguard REIT ETF (NYSEArca: VNQ), are seen as vulnerable to higher interest rates. In recent weeks, investors are reflecting that notion as VNQ has declined 3.3% over the past month.
Previously, REITs and REIT ETFs rallied as the Fed pushes off monetary policy changes. New York Federal Reserve Bank President William Dudley argued that it is too early to think about a rate hike due to concerns about global growth, reports Francesca Landini for Reuters.
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.
VNQ “has a very low expense ratio of 0.12%, which is 91% lower than the industry average. Vanguard Equity Investment Group is the ETF adviser. The fund pays a substantial dividend yield of 3.9%, which is attractive to many investors. The price-to-earnings (P/E) ratio for the fund’s holdings is 35.7, with a price-to-book (P/B) ratio of 2.3,” according to Investopedia.
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.
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]
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]
“Modern portfolio theory (MPT) seeks to construct optimized portfolios by measuring the diversification of the assets in the portfolio. The fund has a low beta of 0.33 versus the larger stock market. The fund also has a low R-squared of 0.04 with the stock market. This indicates that the fund’s returns are statistically not related to the movement of the stock market. Further, rather than having to invest directly in real estate, investors can easily buy and sell shares of the ETF. This makes diversification easy and cost effective,” adds Investopedia.
Vanguard REIT ETF
