Exchange traded fund investors who are considering the factors that go into real estate performance can consider an investment methodology that targets specific characteristics to enhance exposure to the sector in today’s volatile market.
In the recent webcast, How Real Estate is Positioned for Today’s Markets and Economy, Kevin Davis, Chief Growth Officer, Vident Financial; and Jerry Bowyer, Chief Economist, Vident Financial, argued that the market is presenting an opportunity in the real estate segment today, with real estate investment trusts providing a source of yield generation for income seekers, but some areas of the sector could stand out more than others.
The strategists pointed out that REITs have provided investors with long-term growth opportunities that have beaten out both the broader bond and equity markets. For example, the real estate FNRETR Index has generated an average annualized return of 9% over the past 20 years, compared to the 5% return for the Barclays U.S. Aggregate Bond Index and 6% for the S&P 500 Index.
The REITs sector may also be a good diversifier during a pullback or periods of market weakness. The strategists argued that REITs have the potential for downside protection during recessions. During the normal market cycle from 1991 through 2018, U.S. REITs showed a -9.6% decline during a recession, compared to the steeper -17.7% drop off for the S&P 500.
However, not all REITs are created equal, and investors will find that some may outperform and underperform. For instance, so far this year, hotel REITs plunged 58.7%, casino REITs plummeted 48.3% and development REITs retreated 45.8%. In comparison, data center REITs were only down 8.6%, communications REITs dipped 11.3% and self-storage REITs fell 23.3%.
More importantly for fixed-income investors, REITs come with attractive yield-generating opportunities. For instance, the Vident U.S. Diversified Real Estate Index showed a 4.89% yield as of mid-March, compared to the 2.54% yield for the S&P 500 and 1.72% yield for the Barclays U.S. Agg.
As a way to help investors access the real estate segment, Vident Financial has come out with the U.S. Diversified Real Estate ETF (NYSE Arca: PPTY). The ETF adheres to four main factors when constructing a diversified portfolio, including location, property type, leverage, and governance.
The location factor refers to a key driver of real estate performance. Stable targets are used to diversify geographic exposure while favoring dynamic, high-growth locations. PPTY’s geographic targets increase exposure to relatively attractive retail locations such as New York City, Washington, D.C., and Los Angeles.
Property type is based on the fact that differences between property types matter, so fixed allocations seek to ensure diversification and balance. A traditional market-cap weighted indexing methodology focuses on retail, followed by communication, whereas PPTY’s more balanced approach takes an overweight position to residential, office space and industrial REITs.
The leverage factor corresponds to the responsible use of leverage to enhance returns, but excessive debt creates unnecessary risk, especially during economic downturns. PPTY seeks to reduce allocations to companies with high debt in favor of firms with strong balance sheets.
Lastly, governance covers companies with significant governance risks, which are excluded from the portfolio. The index utilizes two criteria: external management and low free float percentage.
As a way to better diversify an investment portfolio, the strategists pointed out that experts say an investor should have 15% to 20% invested in real estate. As part of a traditional 60/40, equity/bond portfolio mix, Vident argued that investors can replace up to 20% of the fixed-income segment with real estate exposure.