Exchange traded fund investors should consider a differentiated approach to real estate investment trust selection, especially the benefits of short-term REITs that could help enhance a portfolio and better manage potential risks.

In the recent webcast, Why Short-Term REITs Make Sense Now, Alex Graf, ETF specialist, institutional and ESG models, Nuveen, explained that REITs are companies that own or manage income-generating real estate assets. Without having to own the physical property, individual investors can also invest in publicly-traded REITS and earn the attractive dividends from these securities. Graf also highlighted the long-term benefits of short-term REITs, which can adjust pricing more frequently than longer-term REITs, may adapt more quickly to changing market conditions, and can be less sensitive to movements in interest rates.

As investors look for ways to achieve their income objectives, many are faced with the prospect of taking on more portfolio risk, particularly in a lower-for-longer interest rate environment. Consequently, Graf expressed belief that expanding and diversifying the source of risk are both key to an income strategy. This is where REITs could offer competitive returns for income-minded investors.

“As investors contemplate the implications of economic uncertainty on capital markets, it seems a pertinent time to readdress the rationale for real estate in multi-asset portfolios,” Graf said. “For investors reappraising risk and reward, real estate may fulfill a need for diversification, performance, and, importantly, yield, in a world starved of income.”

Michael Orzano, senior director of global equity indices, S&P Dow Jones Indices, highlighted the Dow Jones U.S. Select REIT indexing methodology as a benchmark for investors to gauge the real estate market. Orzano explained that the constituents of the Dow Jones U.S. Select REIT Index are classified into short-, medium-, and long-term buckets based on the typical average lease duration of the different REIT sectors.

Specifically, the short-term bucket includes REITs like apartments, hotels, manufactured homes, and self-storage. The mid-term bucket covers industrial, mixed, industrial/office, strip centers, factory outlets, and diversified REITs. Lastly, the long-term bucket holds healthcare, regional malls, and office REITs.

Orzano pointed out that these various REIT lease durations also exhibit varying degrees of interest rate sensitivity. For example, when comparing sub-sectors to the broader Dow Jones U.S. Select REIT Index during periods of rising interest rates, the frequency of outperformance was highest among short-term sectors like hotels 100% of the time, apartments 67%, and self-storage 67%.

“Dow Jones U.S. Select Short-Term REIT Index outperformed the broader REIT market during short-term spikes in the 10-Year Treasury yield with greater consistency during higher magnitude rate increases,” Orzano said. “The index neither outperformed nor underperformed in periods of falling rates.”

For example, the Dow Jones U.S. Select Short-Term REIT has offered downside protection during recent episodes of rising rates.

REITs with shorter term leases “have generally outperformed the Dow Jones U.S. Select REIT Index during periods of interest rate spikes, driven partially by their ability to reprice more quickly than other segments of the REIT market,” Graf said.

Orzano noted that the short-term REIT segment has exhibited improved risk/return characteristics compared to the broader REIT market. They exhibited higher returns in all measured time periods, coupled with lower volatility over the long term, and the short-term segment showed a similar dividend profile over a five-year average despite recent declines.

As a way to help investors capture the short-end average lease duration in the REITs space, investors can look to the NuShares Short-Term REIT ETF (BATS: NURE), which tries to reflect the performance of the Dow Jones U.S. Select Short-Term REIT Index. The fund’s strategy offers access to REITs with short-term lease agreements which may be less volatile and sensitive to interest-rate changes than longer-term REITs, with the potential for attractive risk-adjusted returns.

Financial advisors who are interested in learning more about real estate investment trusts can watch the webcast here on demand.