By Eric Dutram
Given the slightly improved economic picture, and mild declines in unemployment, many investors may assume that housing would finally be back on track. However, the U.S. residential property market has been mixed at best as recent readings of the S&P Case Shiller Home Price Index showed month-over-month declines of about 0.5% while year-over-year prices tumbled by about 4% in comparison. This data contrasts sharply with some of the other housing figures investors have seen lately—specifically, inventory levels and existing home sales—which suggested to some that a recovery was finally underway in the sector.
Obviously, that idea is now seriously in question with the latest Case-Shiller reading, pushing many to wonder if housing really is approaching a bottom or not. Yet, despite all the ills in the residential sector, signs of life are starting to appear in the commercial space instead. The National Association of Realtors predicts that vacancy rates will decline slightly across all segments of the market this year including a nearly one percent drop in industrial and retail markets. Add this to solid gains in the Society of Industrial and Office Realtors CRE Index—which is finally on the upswing although still subdued overall—and investors may be better served by playing real estate via the commercial sector.
In addition to arguably better fundamentals, commercial real estate can also offer up valuable diversification benefits as well. This is because most investors are already exposed to the residential market via their homes, but most do not have a similar allocation to commercial properties as well. Thanks to this, some assets in commercial real estate could help to give investors a more well-rounded outlook on the broader sector.
While there are a few stocks and bonds that can offer up quality exposure to the space, an ETF could be the way to go in this market. That is because a fund will help to spread holdings around a variety of geographies and nearly eliminate company specific risk as well. This can be ideal if commercial real estate dips back or if the current trends in the market do not hold up and some providers are left with heavy losses. As a result, a closer look at either of the following two ETFs could be appropriate for investors seeking more exposure to the commercial side of the real estate market:
iShares FTSE NAREIT Industrial/Office ETF (FNIO)
While pretty much all real estate ETFs have at least some exposure to the commercial real estate market, FNIO is the only one that focuses exclusively on this segment. This is done by tracking the FTSE NAREIT Industrial/Office Capped Index which produces a fund that charges investors 48 basis points a year in fees and holds 30 securities in its basket. Top holdings include ProLogis (PLD) and Boston Properties (BXP) which both make up about 18% of the fund. In terms of market cap breakdowns, the fund is pretty spread out as large and small cap stocks each make up about 37% of FNIO. While the yield is pretty solid at 3.2%, volume and AUM is pretty light, suggesting that wide bid ask spreads may be inherent in this fund.
iShares Barclays CMBS Bond Fund (CMBS)
If investors are still unsure about equities but want quality exposure to the commercial real estate market, CMBS looks to be a great choice. The product tracks the Barclays Capital U.S. CMBS (ERISA Only) Index which follows a benchmark of commercial mortgage-backed securities. These notes generally consist of a number of commercial real estate mortgages across a variety of sectors in this space. They are similar to residential mortgage-backed securities but due to the structure of the commercial market, commercial bonds often carry less in prepayment risks than their residential counterparts.
For investors who are intrigued by this approach—and fixed income investors should be considering that CMBS securities make up a very small portion of broad bond funds—a few more points should be noted. The fund charges just 25 basis points a year in fees but holds just about 30 securities in its basket. Also, volume and AUM is pretty low, but the product is still young, having debuted in mid-February. Nevertheless, the fund’s holdings include a series of bonds which have coupons in the 5.4%-5.8% range that mature over the next few years, suggesting low default risks in this corner of the market.