Although it is widely expected that the Federal Reserve will raise interest rates for the third time this year when the central bank meets in December, that is not keeping some investors from embracing rate-sensitive assets, such as real estate exchange traded funds.
For example, the Shares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) just capped one of its best weeks of adding new assets in some time.
“The iShares U.S. Real Estate ETF, ticker IYR, took in $425 million last week, the largest weekly inflow in almost a year. The fund hadn’t seen more than $400 million since last December,” reports Bloomberg.
Real estate investment trusts, or 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.
Like other high-yielding asset classes, REITs are viewed as sensitive to interest rate increases. The Federal Reserve has boosted borrowing costs twice this year, with most recent coming in June, and many bond market observers believe a third rate hike will arrive before 2017 is over.
Consequently, when rates and yields rise, REITs are sold off on expectations of higher costs for financing real estate acquisitions, and their dividends become less attractive against less risky Treasuries.
“IYR has trailed the broader S&P 500 over the last year, making the real estate ETF a relatively cheap option for investors looking to capitalize on a value play, said Matt Schreiber, president and chief investment strategist at WBI Investments. That and the search for higher yields is why his firm now owns almost 30,000 shares of the fund,” according to Bloomberg.
REITs provide diversification benefits as the asset shows a lower correlation to stocks and bonds. However, the asset category has recently experienced heightened volatility due to interest rate risks. 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.
Real estate “is the best performer in the S&P 500 Index over the past month, gaining more than 4 percent and handily outpacing the broader market,” according to Bloomberg.
For more information on real estate investment trusts, visit our REITs category.