Booming Real Estate Market Helps REIT Returns Outpace The S&P 500

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Includes: DRA, DRN, DRV, FREL, FRI, FTY, IARAX, ICF, IYR, JRS, KBWY, LRET, NRO, PSR, REK, RFI, RIF, RIT, RNP, RQI, RWR, SCHH, SRS, URE, VNQ, WREI, XLRE
by: Than Merrill

Summary

REITs significantly outperformed the S&P 500 in March and the first quarter of 2016.

Real estate trusts provide investors with attractive dividends and a risk-averse strategy that is less susceptible to the volatility of today's market.

The momentum of the housing sector has contributed to the recent success of REITs.

Positive trends within the real estate sector have exceeded expectations, and stock market investors couldn't be more excited. The recent performance of the housing market has contributed to higher dividend yields exhibited by real estate investment trusts (REITs) at the end of 2016's first quarter.

Real estate has been on an absolute tear for the better part of two years, and 2016 doesn't appear to be an exception. If for nothing else, the momentum gained last year looks to have carried over into the new year and picked up steam. What's more, market fundamentals are better off now than they have been since the onset of the Great Recession: equity has returned to homeowners in droves, interest rates continue to encourage activity, the job market is the best it has been since the turn of the century, and the long-awaited arrival of Millennial homebuyers appears to be upon us. At the very least, it is easy to see why so many people are excited for the direction the housing sector is heading.

However, more people need to be excited about the impact a healthy real estate market has had on stocks. In particular, REITs have piggybacked off of the recent performance of real estate and become a very attractive investment option in their own right. According to the National Association of Real Estate Investment Trusts (NAREIT), "stock exchange-listed Equity REITs significantly outperformed the rest of the equity market in March and the first quarter of 2016."

In March, returns witnessed in the FTSE/NAREIT All REIT Index outperformed the whole of the S&P 500. The REIT benchmark index rose approximately 9.99%, whereas the broader market increased 6.78 percent. The pace of the REIT market, however, isn't a new development, but rather the continuation of a trend we have seen take place over the course of 2016. Since January, the FTSE/NAREIT All REIT Index has managed to gain 5.86%, whereas the S&P 500 increased returns by only 1.35 percent.

"REIT share prices, along with those of most other segments of the equity market, faced headwinds in January and early February, but REITs experienced a stronger recovery than the broader equity market in March," said NAREIT president and CEO, Steven A. Wechsler.

While REITs have managed to secure better dividends for investors on the year, March was exceptionally generous.

"It was the kind of month where equity investors in general did well in essentially all categories of the stock market," said Brad Case, NAREIT's senior vice president for research and industry information. "But, certainly you were better off if you were a REIT investor," he added.

According to Case, "there wasn't a bad place to be in the REIT industry last month, and that mostly holds true for the first quarter as well."

It is important to note, however, that the latest gains in the REIT industry were not necessarily surprising. Economic indicators have hinted at the resurgence of REITs since the Fed announced they would gradually increase interest rates back in December. If for nothing else, the gradual removal of the low interest rate "crutch" meant the economy was healthy enough to stand on its own two feet. What's more, REITs thrive during times of economic prosperity.

"As long as we see higher interest rates driven by economic growth and job growth, that should be supportive of demand for commercial real estate," says Steve Shigekawa, a senior portfolio manager at Neuberger Berman.

Economic growth has essentially bridged the gap separating markets. The recent success of the real estate market may be attributed to the improvements our economy has made as a whole.

A report issued by the Bureau of Labor Statistics acknowledges that the U.S. economy added 215,000 jobs in March alone.

"The robust pace of job creation continued in March as labor force participation rose for the fourth consecutive month and hourly wages increased. The private sector has now added 14.4 million jobs over 73 straight months of job growth, the longest streak on record, and wage growth has accelerated over the past year," said a White House blog post.

It's no surprise that they health of the economy has contributed to the torrid pace of the real estate market. But how does a healthy real estate market boost the performance of REITs in what has been a volatile stock market thus far in 2016?

A robust economy prompts consumers to spend more than they would in a down economy. That said, employers are more inclined to hire workers when times are good, resulting in the acquisition of more office space from - you guessed it - REITs. Real estate investment trusts, therefore, benefit from fewer vacancies, higher rental prices, improving fundamentals, and better dividend yields.

REITs also provide a more risk-averse investment strategy - something more investors are inclined to favor in the face of a real estate market that got off to a rough start this year.

I can't help but be encouraged by the Vanguard REIT Index ETF (NYSEARCA:VNQ), which invests in stocks issued by real estate investment trusts. Not only has this ETF started to turn heads with its impressive dividend yields, but it has diversified its portfolio enough to navigate a largely volatile market.

"Based on the past four quarterly distributions, the Vanguard REIT ETF yields more than 4% at current pricing. And it VNQ, -0.66% features the typical rock-bottom cost of a Vanguard fund, with an expense ratio of just 0.12%, or $12 annually on each $10,000 invested," according to MarketWatch.

Perhaps even more importantly, however, is how Vanguard has managed to diversify its current portfolio. While the majority of its assets are in retail REITs, it has managed to incorporate residential REITs, office REITs and even healthcare into the mix.

Despite global market volatility, REITs have exceeded expectations. However, those familiar with the industry don't expect them to slow down anytime soon. In fact, it's safe to assume that REITs will outpace the broader market for the foreseeable future.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.