REIT ETFs Enjoying Strong Fundamentals

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 |  Includes: IYR, RWR, VNQ
by: Tom Lydon

Summary

Potential for further upside in REITs even in a rising rate environment.

REITs enjoying strong demand while supply has not been catching up.

Real estate will continue to grow in an expanding economic environment.

Real estate investment trust-related exchange traded funds have oscillated with interest rate expectations, rising this year as rates declined and falling when rates jump. However, some industry experts are down playing the negative effects of rate risk and argue that the sector's fundamentals play a greater role.

Year-to-date, the Vanguard REIT ETF (NYSEARCA:VNQ) has gained 17.8%, iShares Dow Jones US Real Estate Index Fund (NYSEARCA:IYR) rose 15.8% and SPDR Dow Jones REIT ETF (NYSEARCA:RWR) increased 18.1%.

"I don't think interest-rate hikes are a big threat to REITs, and I have a very optimistic and bullish outlook for real estate in 2014 and two years beyond 2014," Kevin Mahn, president and chief investment officer of Hennion & Walsh Asset Management, said in an InvestmentNews article.

Marc Halle, managing director for Prudential Real Estate Investors, believes that a favorable supply-and-demand fundamental will offset any weakness in a rising rate environment. Halle said in the article:

Right now we're seeing generational lows, in terms of the amount of new (commercial construction) product being delivered to the market. REITs offer strong income and they are a natural hedge against inflation, and it is driven by supply and demand.

Specifically, observers point to the slow U.S. growth, which has diminished commercial development over the past six years. Meanwhile, demand has shot up, with the average occupancy rate across all REIT portfolios is now at 93.6%, near its last occupancy-rate peak of 94.3% in 2007. Halle added:

You've already seen hotel rates go up and you're seeing rental rates go up in self-storage and multi-family housing. We haven't seen construction of any type since [the start of the financial crisis], and then you add to that the fundamental reality that, with real estate, you can't just create supply overnight.

Additionally, if the Federal Reserve hikes rates to combat rising inflation, "inflation is real estates' best friend," Burland East, manager of the Altegris/AACA Real Estate Long-Short Fund, said. East said:

Inflation will drive interest rates higher, but it also drives prices higher. Right now we have almost no inflation but rents are going up between 4% and 6% a year.

The three ETFs provide access to a diversified portfolio of REITs. VNQ's top sub-sectors include retail REITs 25.5%, residential REITs 16.2% and office REITs 13.3%. IYR's top sub-sectors include specialty REITs 30.1%, retail REITs 20.% and industrial & office REITs 18.1%, RWR's top sectors include apartments 17.0%, regional malls 16.7% and healthcare 12.9%.

Vanguard REIT ETF

Max Chen contributed to this article.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.