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Retail Exposure Problematic for REIT ETFs

editor@etftrends.com (ETF Trends)

Amid fears of encroachment by Amazon.com Inc. (AMZN) into new retail territories, traditional brick-and-mortar retailers are struggling this year. Even with a gain of more than 4% over the past month, the SPDR S&P Retail ETF (XRT) is still down more than 6% year-to-date while the broader consumer discretionary sector is higher by 11.4%. XRT, the largest retail exchange traded fund (ETF) by assets and often a favorite target of short sellers this year, has been hampered, in part, by exposure to apparel retailers. In fact, apparel retailers are the largest of the 10 retail sub-industry groups represented in XRT, accounting for over 22% of the fund's weight. Some analysts believe struggles for brick-and-mortar retailers will turn into problems retail real estate investment trusts (REITs). “A hypothetical rapid rise in Amazon's U.S. apparel market share could have significant credit implications for existing retailers, REITs and CMBS transactions,” said Fitch Ratings in a recent note. “Sharp declines in retailer revenue and margins and accelerated store closings would likely drive significant cash flow erosion and weaken credit profiles for apparel-focused retailers, mall REITs and retail-heavy CMBS deals in such a scenario.” Retail REIT exposure is something to consider for investors mulling stakes in REIT ETFs as some of the largest funds in this genre have significant weights to these REITs. The Vanguard REIT ETF (VNQ), home to nearly $35 billion in assets under management at the end of July, allocates over 19 percent of its weight to retail REITs. That is more than 10% more than the ETF's second-largest sub-industry weight. VNQ is not just the largest REIT ETF, it is the largest sector ETF of any stripe trading in the U.S. The $4.5 billion iShares U.S. Real Estate ETF (IYR) devotes over 14% of its lineup to retail REITs, its second-largest industry allocation. The iShares Core U.S. REIT ETF (USRT), one of the least expensive REIT ETFs, has an 18.5% weight to retail REITs. Going forward, some REIT ETFs could be pressured by Amazon's retail expansion plans. “The hypothetical rapid growth in Amazon's apparel market share to 25% by 2020 could cut apparel retailer margins by around 300 basis points, pushing several retailers toward financial distress,” said Fitch. Related: How Amazon is Helping Consumer Discretionary ETFs REITs with heavy mall exposure could also be vulnerable to Amazon's expansion and consumers' increased preference for online shopping. “REITs owning regional malls with high exposure to troubled anchor stores and a less diverse tenant base would face heavy cash flow pressure,” said Fitch. “We estimate that as many as 400 of approximately 1,200 US malls could close or be repurposed as a result of retailer liquidations and square footage reductions.” For more information on the consumer sector, visit our consumer discretionary category. Read more on ETFtrends.com