While there are some concerns over real estate investments trusts and sector-related exchange traded funds in a rising rate environment, REITs have underperformed the markets are now attractively priced, especially as the economy continues to expand.
Year-to-date, the Vanguard REIT ETF (NYSEArca: VNQ) rose 0.6%, SPDR Dow Jones REIT ETF (NYSEArca: RWR) gained 1.9% and iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) added 0.5%. Meanwhile, the S&P 500 Index increased 3.0%.
Many have been waiting for shares of REITs to catch up to the broader equities market and reflect the value of the properties that the companies hold, reports Liam Pleven for the Wall Street Journal.
According to Green Street Advisors, REITs are now trading at almost a 12% discount to their net asset value, and in September, the discount was larger than at any point since 2009. Investors, though, have not been jumping at the cheap valuations as many worry about the effects of an interest rate hike or the chance that the economy is weaker than it appears.
Expectations for higher interest rates have dragged on REITs as the dividend-yielding assets look less attractive relative to safer government bonds in a rising rate environment.
“Clearly the markets are signaling some concern about a rate rise,” Michael Torres, chief executive officer of Adelante Capital Management LLC, told the WSJ.
While a December interest rate hike may cause some volatility over the short-term, higher rates reflect the Federal Reserve’s confidence in the expanding U.S. economy. However, in a strengthening economy, REITs will enjoy better fundamentals, such as lower unemployment and rising rents from greater demand out of individual and institutional tenants. [REIT ETFs May Hold Their Own in Rising Rate Environment]
Consequently, Sherry Rexroad, a managing director who oversees REIT investments at BlackRock (NYSE: BLK), projects REITs will see earnings growth of about 8% in 2016.
“You should see REIT prices continue to recover,” Rexroad told the WSJ.
Notably, Rexroad was particularly bullish on REITs that own multifamily apartment buildings since a healthier economy encourages people to form new households but borrowing to buy the first home remains challenge, especially among young workers.
So far this year, large apartment REITs, like AvalonBay Communities (NYSE: AVB) and Equity Residential (NYSE: EQR) are among the best performers.
For residential REITs exposure, ETF investors can take a look at the iShares Residential Real Estate Capped ETF (NYSEArca: REZ), which includes a 46.7% tilt toward residential REITs, including 8.6% in AVB and 10.4% in EQR.
Vanguard REIT ETF
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.