REITs Outperform Stocks, Direct Real Estate

It is ironic that US REITs year-to-date have outperformed US stocks, non-US developed market stocks, and emerging market stocks, as well as directly owned commercial and residential real estate. Only commodities have outperformed REITs so far this year.

Vanguard REIT ETF (VNQ), iShares Cohen & Steers Realty Majors ETF (ICF), iShares Dow Jones US Real Estate ETF (IYR) and SPDR DJ Wilshire REIT ETF (RWR) are still down from 17% to 20% on a trailing 12-month basis, but they provide a 12-month distribution yield of from 3.90% to 4.75% which is more than the current 10-year T-Bond rate of about 3.70%.

How vulnerable REITs are to a reversal of fortune is unclear. If the economy is as vulnerable to major recession as some say, the rental income of REITs may not prove as strong as expected, which would tend to lower the distribution yield. Continued outperformance itself, would reduce the yield rate. Rising interest rates due to inflation* could reverse the yield spread between REITs and T-Bonds, which would take steam from the REITs.

* By inflation, we do not refer to the ridiculous US government published figure that excludes food and energy from the calculation. How absurd to read headlines about inflation being only 2% or 3% excluding food and energy, when oil is $130 per barrel, corn and milk are at historic highs, and local property taxes are rising as if money grew on trees — but that is a topic for another day.

The question for REITs in the near term is whether they will benefit by inflation as they have historically over long periods, or whether this inflation in the short-term will harm them by increasing vacancies, putting supply-demand caps on rental rates and possibly creating negative yield spreads compared to Treasuries.

You should be in the class, but through rebalancing you should also scale out of gains to maintain your target allocations. Harvest gains incrementally and scale into other classes and subclasses (such as large banks) that are in the tank now, but that will eventually have their turn in the sun.