Despite Rate Risk, REIT ETFs Could Still Perform in 2015
Real estate investment trusts and related exchange traded funds experienced their best yearly gain in almost a decade, and the sector could maintain their strength next year, even with rising rates on the horizon.
In 2014, the Vanguard REIT ETF (VNQ) gained 32.6%, iShares Dow Jones US Real Estate Index Fund (IYR) rose 28.7% and SPDR Dow Jones REIT ETF (RWR) increased 34.0%. [Another Nifty Small-Cap REIT ETF]
Meanwhile, FTSE NAREIT Equity REITs Index returned 32.3%, including dividends, in 2014, the highest total since 2006.
REITs have been among the best assets of 2014 as low interest rates and an improving economy helped attract income-minded investors, reports Robbie Whelan for the Wall Street Journal.
REITs provide a liquid alternative to owning physical commercial real estate properties. REITs investments also share similar attributes with stocks and bonds. Since REITs are required to distribute at least 90% of their income from rent payments to investors, these real estate investments can generate attractive yields.
For example, VNQ has a 3.13% 12-month yield, IYR has a 3.36% 12-month yield and RWR has a 2.85% 12-month yield.
Some may be concerned that REITs are sensitive to changes in interest rates. Notably, the fall in interest rates have made the asset more attractive as a yield-generating alternative, but some fear the asset will fall out of favor once rates rise.
Nevertheless, many analysts argue that REIT shares will continue to perform, despite rate risks, since interest rates alone don’t dictate REIT performance and other factors may override rate concerns. For example, a strong economy and greater mergers-and-acquisitions activity could outweigh rate fears.
While Citigroup economists project 10-year Treasury yields will rise to 2.95 by the end of 2015, they argue that REITs could produce a total return of between 5% and 15% for the year. Michael Bilerman, Citi’s head of real estate research, argues that a stronger economy will overshadow rising rate concerns.
“If rates are rising because the economy is doing well…it means rents are rising, and landlords have more pricing power,” Bilerman said in the article.
Notably, apartments and residential REITs stood out in the space. The iShares Residential Real Estate Capped ETF (REZ) has increased 37.7% year-to-date as Americans opted to rent instead of purchase a new home this year. [Meet This Year’s Best Financial Services ETF]
However, market observers warn that if interest rates suddenly spike instead of a gradual rise, REITs could experience a quick sell-of similar to what happened in May 2013 after the Fed suggested it would cut its bond-purchasing program, which caused rates to surge.
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
