The Federal Reserve decided to leave interest rates unchanged after its two-day meeting in April, giving another short-term boost to the real estate sector.
The Vanguard REIT Index Fund (VNQ), which tracks the entire U.S. real estate investment trust marketplace, has been gaining and is already ahead by 4.99% year to date. VNQ, the largest U.S.-listed REIT ETF with $30.53 billion in assets, has outperformed the entire U.S. stock market over the past year by almost 5%. And since the start of the year, VNQ has continued by outperforming the broader stock market by 1.91%.
Despite getting clobbered during the height of the credit crisis in 2008 — losing 36.94% — U.S. REITs have bounced back. Since then, REITs have assembled an impressive performance streak of seven consecutive years of gains that began in 2009. And if REITs continue at their current pace, this year could turn into an amazing streak of eight back-to-back yearly gains.
REITs are companies that own, manage and develop income-producing real estate. Congress created the REIT industry in 1960 as a way to make larger-scale, income-producing real estate accessible to the average investor. (Most REITs are publicly traded; nontraded REITs carry additional risks.)
Although the first REITs introduced in the early ’60s were mostly mortgage companies, the sector has greatly expanded to include office, industrial, residential and commercial retail properties.
In the domestic REIT marketplace, mortgage REITs are outperforming other subsectors like apartments. The iShares FTSE NAREIT Mortgage REIT ETF (REM) is ahead 5.77% year-to-date versus a gain of just 1.44% for the iShares FTSE NAREIT Residential REIT ETF (REZ).
REITs are sensitive to changes in interest rates but relatively low borrowing costs over the past several years have helped the sector to keep humming along.
The U.S. federal funds rate has been held between 0.25% to 0.50% since last December when the Fed boosted short-term interest rates after a six-year streak of near zero percent rates.
REITs are an attractive choice for income investors. By law, they must pay out 90% of their income to shareholders via dividends. That means REIT shareholders, not the company, receive the bulk of income collected from real estate holdings.
Also, REITs compare very favorably right now against lower yielding bonds. For example, the yield on 10-year U.S. Treasuries is around 1.85% while the 12-month yield on broadly diversified REIT ETFs hovers near 4%. International real estate is a missing area within many investor portfolios that is showing positive trends.
The Vanguard Global ex-U.S. Real Estate ETF (VNQI) is ahead by 7.49% year to date. VNQI charges 0.18% annually and carries a 2.84% yield. Around two-thirds of VNQI’s holdings are focused on foreign real estate in North America (outside the U.S.) and South America; about 21% is in invested in Asia and 13% in Europe.
Aside from offering broad diversification, REIT ETFs also give investors intraday liquidity by allowing them to buy and sell shares during regular market trading hours. In contrast, converting traditionally owned real estate into liquid cash takes time. The daily liquidity of REIT ETFs is a convenient way to invest in a liquidity-challenged asset class.
During the first quarter, ETFs linked to REITs contributed to 2.4% ETF asset growth quarter over quarter to $2.3 trillion.
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