Yield, Outperformance Attract Investors To Real Estate ETFs

Includes: FRI, FTY, RWR, VNQ
by: Tom Lydon

While investors have jumped into real estate investment trusts and exchange traded funds to cash in on the attractive yields, REIT prices have edged higher, causing some to take pause from a valuation standpoint.

The MSCI U.S. REIT Index has gained an average 19% per year over the past three years, including dividends, reports Tom Lauricella for The Wall Street Journal.

"U.S. REITs look less attractive to us now than they have over the last 10 years," Richard Levine, one of the portfolio managers of the Neuberger Berman Equity Income Fund, said in the article. "As people have looked for the next source of yield they've found REITs, so they've done nicely. But that's been pushing valuations to levels which are unattractive in some cases."

REITs operate a range of real estate properties, such as hotels, hospitals, apartments and storage units, among others. To receive favorable taxes, REIT companies are required to distribute 90% of their taxable income to share holders, which is why REITs provide such attractive yields.

The asset class is typically valued in comparing prices to adjusted funds from operation, or AFFO, a type of net-income use for real estate. According to Green Street Advisors, REITs are trading at 18 times their stock prices using a three-year forward AFFO, compared to an average of 15 times since 1998.

While valuations may be a cause for concern, fund managers and analysts are not overly bearish. REITs still benefit from the low interest rate environment, little new construction and positive economic growth.

The REITs market has also benefited from the slowly recovering real estate market. Additionally, some investors have used commercial real estate as a way to hedge against inflation -- as landlords, REITs operators can just raise the rents during inflationary periods.

Some REIT ETFs include:

  • Vanguard REIT ETF (NYSEARCA:VNQ): 3.41% yield
  • SPDR Wilshire REIT ETF (NYSEARCA:RWR): 3.10% yield
  • iShares FTSE NAREIT Real Estate 50 Index Fund (NYSEARCA:FTY): 3.66% yield
  • First Trust S&P REIT Index Fund (NYSEARCA:FRI): 2.36% yield

Max Chen contributed to this article.

Disclosure: I 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.