REIT ETFs Can Do No Wrong


Judging by the stellar performance of REIT ETFs in 2010, it is hard to imagine that real estate has barely recovered from of a major crisis. But a predicted tsunami of foreclosures rolled in as only a sizeable wave, and now analysts forecast solid cash flow gains for publicly-traded REITs in 2011.Do prices, which surged 19 percent in 2010 according to the MIT Center for Real Estate, reflect underlying economics? At present a neutral weighting is justified, but if REIT ETFs continue to climb steeply, reallocation elsewhere will make more sense.Economic fundamentals for commercial real estate remain precarious in many markets. Deutsche Bank foresees a huge number of properties having to refinance in coming years with underwater valuations (at least at todays prices). Delinquencies in commercial mortgages bundled and sold as bonds increased to 8.79 percent in December 2010 from 4.9 percent a year earlier, according to Moodys, although the pace of growth in delinquencies is slowing.Still, macroeconomic indicators are improving. Employment, the single best predictor for demand for office space as companies try to find seats for their new workers, is inching up steadily. And consumer spending, which drives retail occupancy, is holding steady. Also, a flood of credit from the Federal Reserve is allowing many banks to push out loans for problem buildings. What was derided as an extend and pretend policy may yet succeed. Commercial mortgage-backed bonds have hit two-year highs. And from the investors perspective, the Feds continued policy of low interest rates has made REITs yields comparatively attractive.As to the steepness of the price rebound, the mathematics of price swings are always asymmetric. A modest loss in percentage terms requires a huge gain in percentage terms for a stock's price to rebound. Since REITs were badly beaten down, a snapback delivers phenomenal returns such as seen in US REIT ETFs in 2010:

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Mainstay US funds did well, including iShares Cohen & Steers Realty Majors ETF (NYSEArca:ICF - News) at 0.35% fees and iShares Dow Jones US Real Estate ETF (NYSEArca: IYR - News) at 0.48% Vanguard REIT ETF (AMEX:VNQ - News) with a phenomenal 0.12% annual expense ratio.It is helpful that REIT ETFs do not reflect the entire real estate industry but instead just portfolios of the largest properties and brands. Much of the carnage is occurring with small, aggressive private equity players such as in minor Miami condo or Phoenix mall projects. Multifamily REITs which made it this far benefit from scooping up distressed condo and converting them to rentals. Retail REITs are likewise grabbing half-empty malls for pennies on the dollar.What do the experts say now?ING Investment Management (INGIM) expects US as well as global REITs to deliver total returns of 8 - 12 per cent in 2011. Despite poor fundamentals, a reversal is within sight and investors are jumping on board.REIT ETFs have successfully completed a turnaround play and are now entering a momentum investment phase, much like a growth stock mid-way into recovery. The problem is that much of the industry has not recovered. This is an asset class known traditionally for steady dividend distributions and modest capital appreciation, but it is not in a traditional environment. In mid-2009 we concluded that REITs ETF prices had fallen so far they were at a fair market bottom. Now they are increasingly an asset class for speculation only and are approaching their fair market ceiling. It is anyone's guess how long the Fed can or will want to keep flooding the market with liquidity. The last time it did this, an asset bubble occurred.Other broad market US REIT ETFs include:
  • iShares FTSE EPRA/NAREIT North America ETF (NasdaqGM:IFNA - News); 0.48% annual fees
  • First Trust S&P REIT ETF (AMEX:FRI - News); 0.70% fees
  • iShares FTSE NAREIT Real Estate 50 ETF (NYSEArca:FTY - News); 0.48%
Picking the right sub-sector clearly can make a difference. Sub-sector ETFs of the above chart include:
  • iShares FTSE NAREIT Industrial/Office ETF (NYSEArca:FIO - News); 0.48% annual fees
  • iShares FTSE NAREIT Mortgage ETF (NYSEArca:REM - News); 0.48%
  • iShares FTSE NAREIT Residential ETF (NYSEArca: REZ - News); 0.48%
  • iShares FTSE NAREIT Retail ETF (NYSEArca:RTL - News) ;0.48%
Going international is attractive at times because it dampens volatility and protects against dollar devaluation. Choices include:
  • First Trust FTSE EPRA/NAREIT Global Real Estate ETF (NYSEArca:FFR - News); 0.6% annual fees
  • iShares FTSE EPRA/NAREIT Asia ETF (NasdaqGM:IFAS - News); 0.5% fees
  • iShares FTSE EPRA/NAREIT Europe ETF (NasdaqGM:IFEU - News) 0.48% fees
  • iShares FTSE EPRA/NAREIT Global Real Estate ex-US ETF (NasdaqGM:IFGL - News); 0.48% fees
  • iShares S&P World ex-US Property ETF (NYSEArca:WPS - News); 0.48% fees
  • WisdomTree International Real Estate ETF (AMEX:DRW - News); 0.58%
While not a REIT ETF, PowerShares Dynamic Building & Construction Portfolio ETF (AMEX:PKB - News), contains firms serving the housing industry though no actual builders.Two interesting trader's tools are expected in Q2 of 2009:
  • MacroShares Major Metro Housing Down ETF (NYSEArca:DMM - News); 1.25% fees
  • MacroShares Major Metro Housing Up ETF (NYSEArca:UMM - News); 1.25%
They track S&P/Case-Shiller Indexes of residential housing in 10 major US metro areas.Investors who want to add an active element to their strategy should look to PowerShares Active U.S. Real Estate ETF (NYSEArca:PSR - News), costing 0.8% in annual fees. PSR uses quantitative and statistical models to try to beat the FTSE NAREIT Equity REITs Index, and it generally makes changes once a month. This is basically the same as a fundamental, semi-active, or intelligent ETF and is worlds away from subjective individual stockpicking.Finally, traders can make directional, leveraged short-term bets on REITs with:
  • ProShares Ultra Real Estate ETF (AMEX:URE - News); 0.95% annual fees
  • ProShares UltraShort Real Estate ETF (AMEX:SRS - News); 0.95% fees
Co-founder of, author of two books on investing, and founder of, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.
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