Will a Faltering Real Estate Sector Spell Doom for Cyclical Equities?

The financial crisis over a decade ago certainly put the big hurt on real estate as exorbitant valuations fed into inflated loan-to-value ratios that helped spur the mortgage crisis, particularly when it came to subprime lending. Fast forward to the coronavirus pandemic, a crisis of a different nature, and real estate is once again feeling the pain—in this case, the commercial real estate market.

Per a recent MarketWatch report, “Hotel rooms sit empty. Office buildings have gone dark. Families cook in their kitchens instead of dining out at restaurants and stream movies at home. The coronavirus pandemic has turned the $4.4 trillion U.S. commercial real estate finance market upside down, even as states start to explore ways to safely reopen parts of the economy after imposing strict lockdowns that cut landlords off from monthly rents.”

Does this sound eerily similar to crises in the past?

“We can’t compare it to 9/11. And if you go back to 2008, that was more about overleverage and looser underwriting,” said Ann Hambly, the founder of 1st Service Solutions, a firm specializing in assisting commercial property owners to navigate loan workouts.

Moreover, the coronavirus pandemic is having a wider reach in terms of economic impact.

“It didn’t affect everyone,” she told MarketWatch of past downturns. “Here, the whole economy has been shut down and everybody needs help.”

The report went on to address that while delinquencies on commercial mortgage-backed securities (CMBS) was just 2.57% during the month of March, the full impact of the pandemic is still yet to come. This could be reflected in numbers for April and beyond.

One way to play a possible slowdown in commercial real estate is via relative exchange-traded funds (ETFs) like the Direxion MSCI Defensives Over Cyclicals ETF (NYSEArca: RWDC). RWDC provides a means to not only see defensive sectors perform well, but a way to capitalize on their outperformance compared to cyclical sectors.

RWDC tilts towards defensive sectors like health care and consumer staples as shown in the fund’s breakdown. Conversely, it shorts names like the top technology giants that skew towards momentum. RWDC seeks investment results that track the MSCI USA Defensive Sectors – USA Cyclical Sectors 150/50 Return Spread Index.

The index RWDC tracks specifically the measures the performance of a portfolio that has 150% long exposure to the MSCI USA Defensive Sectors Index (the “Long Component”) and 50% short exposure to the MSCI USA Cyclical Sectors Index (the “Short Component”). All in all, If investors feel that defensive sectors will get the nod moving forward, they best give RWDC a closer look.

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