EC Are Real Estate ETF Yields Still A Bargain?

This year’s winner in the alternative investment space is—wait for it—real estate.

Among exchange traded funds (ETFs) that invest in real estate investment trusts (REITs), those employing leverage have zoomed to the upside; even non-leveraged funds, cranking out more pedestrian gains, have outgunned stocks and bonds. (See Table 1.)

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REITs have, in fact, been beating stocks and bonds over the past one-, three-, five- and 10-year periods, but generally with higher volatility. (See Chart 1.)

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Over those historic periods, REITs have behaved mostly like equities. That is, until now.

Take a look at Chart 2. Over the past five to 10 years, the Dow Jones U.S. Real Estate Index has been strongly correlated to the S&P 1500 Index, a proxy for the domestic equity market. Correlations to the Barclays Aggregate Credit Index, a broad-based bond benchmark, have been historically slight. Those relationships, however, have been twisted in the past year. In the past three months in particular, they’ve actually flipped. REITs are now acting more like bonds than stocks.

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The reason’s pretty simple: REITs, in this yield-hungry world, are seen as bond substitutes. Look at the dividend yields for REIT ETFs in Table 1. The current distribution yield on the Barclays Aggregate Credit Index is just 2.1 percent. Payouts for non-leveraged REIT funds are 60 percent higher.

There’s another reason. Investors believe REIT funds are immune from duration risk. They’re right, technically speaking, but there can still be exposure to rising interest rates. Duration risk represents a security’s sensitivity to changes in rates. Values for longer-dated paper—i.e., securities with greater duration—are prone to decrease more dramatically than short-term notes and bonds for a given hike in rates. REITs and REIT funds don’t have maturity dates, but some of their investments still have fuses that could be ignited by rising rates.

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DisclosureBrad Zigler pens Wealthmanagement.com's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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