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An Interesting International Real Estate ETF

ETF Professor

Amid rising interest rates in the United States, rate-sensitive real estate stocks are languishing. The Vanguard MSCI U.S. REIT ETF (NYSE: VNQ), the largest exchange traded fund tracking the real estate sector, is down nearly 7 percent this year.

International real estate investment trusts are not providing shelter from the storm. VNQ's international cousin, the Vanguard Global ex-U.S. Real Estate ETF (NASDAQ: VNQI) is sporting a double-digit year-to-date loss.

What Happened

VNQI, which tracks the Vanguard Global ex-U.S. Real Estate ETF, has been hindered by a confluence of factors, including lagging developed markets outside the U.S., weakness in emerging markets equities (20.1 percent of VNQI's roster) and speculation that some ex-U.S. developed markets could follow the Federal Reserve in boosting interest rates.

The other factors driving international real estate stocks and some analysts see opportunity ahead with the $5.50 billion VNQI.

“There are some significant differences between the U.S. real estate asset class and its foreign counterparts,” said Morningstar in a recent note. “U.S. interest-rate movements are U.S. REITs' single largest driver, while local interest rates and property development drive foreign real estate firms. Also, largely because the REIT structure requires firms to pay out at least 90% of their taxable income to shareholders, U.S. REITs' payouts are higher than foreign real estate companies' payouts.”

Why It's Important

VNQI has some important differences relative to domestic funds like VNQ to consider. For yield players, VNQI may be the better idea. The international real estate fund has a trailing 12-month dividend yield of 5.23 percent, or about 115 basis points above VNQ's yield.

Additionally, VNQI features more exposure to non-REIT stocks, including property developers.

“Developers focus on constructing spaces on new or underutilized land. REITs are restricted from breaking new ground in some countries, but property developers can take on more-speculative projects,” said Morningstar. “Developers are more volatile than REITs because their cash flows are less predictable and their payout ratios generally are lower.”

What's Next

At the geographic level, the Asia-Pacific region is vital to VNQI's price action as Japan, Hong Kong, China and Australia combine for 53.8 percent of the ETF's roster. With an expense ratio of 0.14 percent per year, or $14 on a $10,000 investment, VNQI is cheaper than 87 percent of competing strategies, according to issuer data.

Morningstar has a Bronze rating on VNQI.

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