Torn between rising rate concerns and the Trump-induced economic progress while taking an investment decision in the REIT ETF space? Agreed, investors had left rate-sensitive sectors like the real estate investment trust (REIT) in dire straits in Q4 of 2016 thanks to the sharp spike in treasury yields. But things may turn brighter for the space this year. Let us tell you why.
Economic Recovery: A Boon to REITs
U.S. GDP growth was 3.5% in the third quarter - the two-year best. Personal consumption, investment and government expenditure grew faster than anticipated in Q3. Meanwhile, consumer confidence peaked to a 15-year high in December, buoyed by the Trump-induced market rally and a stable job market. Unemployment rate remained low at 4.7%. With economic activity growing, landlords can ask for higher rents for their properties.
Hedge Against Inflation
As per reit.com, REITs are viewed as a protection against inflation. Real estate rents and values tend to grow over the longer term along with prices. This, in turn, will lead to REIT dividend growth and ensure a stream of current income in an inflationary backdrop.
Now, the U.S. economy is showing signs of higher inflation in the near term as evident from the 1.7% year-over-year rise in the U.S. consumer prices in November 2016. This follows a 1.6% rise in October and was also in line with market expectations. This was the highest inflation rate since October 2014.
In such a macroeconomic environment, REITs should thrive. In last 20 years save two, REITs' dividend rise has topped inflation.
Benchmark-Beating Dividend Yield
As of January 6, 2016, the yield on the 10-year U.S. Treasury was 2.42%. On the other hand, several REIT ETFs offer benchmark-beating yields. The largest REIT ETF Vanguard REIT Index ETF (NYSEARCA:VNQ) yields about 4.72% annually while PowerShares KBW Premium Yield Equity REIT Portfolio ETF (NASDAQ:KBWY) yields about 6.52%. So, the Fed's policy tightening and the resultant rise in bond yields should not be much of a problem for REITs.
REIT ETFs have had a modest run in 2016. REITs returned lesser (up 9.3%) than the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) (up 13.6%) in 2016. Such decent valuation opens up room for REITs to outperform ahead.
Already, the FTSE/NAREIT All REIT Index started gaining momentum, having offered about 4.2% returns in December and outperforming the S&P 500 (up over 2%). Several analysts are of the view that in 2017, REITs were watched more for earnings and dividend growth, and less for interest rate sensitivity.
Having said this, it is still a bit tricky to pick REIT ETFs at the current level given all the speculation about rising rates expected in the rest of this year. We have thus zeroed in on a few ETFs that yield heftily and have relatively lower P/E ratios.
Global X SuperDividend REIT ETF (NASDAQ:SRET)
SRET gives exposure to the 30 highest-yielding global REITs. The U.S. has the highest exposure at 87.58%.
P/E- 13.88 times
Yield - 7.86%
First Trust Heitman Global Prime Real Estate ETF (NYSEARCA:PRME)
It is an actively managed ETF. The U.S. (35.7%) and Japan (13.42%) get the top-most weights in the fund.
P/E- 13.43 times
Yield - 5.56%
VanEck Vectors Mortgage REIT Income ETF (NYSEARCA:MORT)
The fund looks to track the performance of the MVIS Global Mortgage REITs Index which focuses on the mortgage real estate investment trusts.
P/E- 14.58 times
Yield - 8.01%
SPDR Dow Jones REIT ETF (NYSEARCA:RWR)
In the U.S.-only REIT ETFs section, P/E ratios are relatively elevated. Still, RWR seems comparatively less pricey.
P/E- 28.65 times
Yield - 4.31%