Real estate investment trusts (REITs) and the corresponding exchange traded funds are benefiting from the still low interest rate environment and the Federal Reserve’s ongoing delays in delivering even modest increases to borrowing costs.
One of the prime beneficiaries of that theme is the Vanguard REIT ETF (NYSEArca: VNQ), the largest real estate ETF and one of the category’s least expensive funds. Expectations for higher interest rates usually drag on REITs as the dividend-yielding equity asset look less attractive relative to safer government bonds in a rising rate environment.
Some analysts have also dismissed claims that there is a bubble in the real estate space where prices have been rising, contending that the higher prices reflect the dearth in supply. While the Federal Reserve is moving toward interest rate normalization, the Fed has reassured markets that it will make gradual hikes.
REITs and REIT ETFs are seen as vulnerable to higher interest rates. Good thing the Federal Reserve continues to sound a dovish tone on borrowing costs.
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.