DRN: Economic Scenario Unfavorable For Leveraged Bull Diversified REIT ETFs


  • DRN’s underlying index performed poorly, and due to the fund’s 3X investment in derivatives of the component stocks, the loss got compounded - the usual story.
  • Around 3/4th of the index’s investments recorded loss over the past 1 year, and within that almost 20 percent had high negative growth.
  • In a scenario of rising inflation, REITs are generally a good bet, provided investors are selective about their compositions.
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Direxion Daily Real Estate Bull 3x Shares ETF (NYSEARCA:DRN) seeks daily investment results, before fees and expenses, of 300% of the performance of the Real Estate Select Sector Index. DRN was launched by Direxion Investments on July 16, 2009 and is domiciled in the United States. The fund invests in derivatives in stocks of companies operating across all segments of real estate investment trusts (REITs). As a 3x leveraged ETF, the fund by default has a high expense ratio of 0.96 percent.

DRN seeks to track 3x the daily performance of the Real Estate Select Sector Index, an index provided by S&P Dow Jones. Funds like Real Estate Select Sector SPDR (XLRE) replicate the composition of such indexes, so their composition is similar to DRN's. Real Estate Select Sector Index as well as XLRE diversified its investments over all types of REITs - Office & Commercial REITs, Retail & Hospitality REITs, Residential REITs, Healthcare REITs, Specialized REITs, and Industrial REITs.

In the case of XLRE, 24 percent of its investments are in seven Industrial REITs primarily engaged in the business of logistics & warehousing. These companies are Prologis Inc. (PLD), Public Storage (PSA), Weyerhaeuser Company (WY), Extra Space Storage Inc. (EXR), Duke Realty Corporation (DRE), Iron Mountain Incorporated (IRM) and W. P. Carey Inc. (WPC). These 7 companies generated an average return of almost 9 percent over the past one year, which is quite impressive as compared to other segments of REITs. Barring PLD, all other REITs have generated significant price growth (in the range of 4 percent and 18 percent) in the past one year.

XLRE invested another 24 percent of its fund in three big communication infrastructure REITs, namely American Tower Corporation (AMT), Crown Castle International Corp. (CCI), and SBA Communications Corporation (SBAC). CCI fell by almost 10 percent, and SBAC grew by almost 3.5 percent, while AMT suffered a marginal price loss. Residential REITs such as AvalonBay Communities, Inc. (AVB), Equity Residential (EQR), Mid-America Apartment Communities, Inc. (MAA), Essex Property Trust, Inc. (ESS), Camden Property Trust (CPT), and UDR, Inc. (UDR), generated an average negative growth of 3.7 percent.

Retail & hospitality REITs like Realty Income Corporation (O), Simon Property Group, Inc. (SPG), Kimco Realty Corporation (KIM), Regency Centers Corporation (REG), Federal Realty Investment Trust (FRT), VICI Properties Inc. (VICI), and Host Hotels & Resorts, Inc. (HST), generated an average negative growth of 7 percent over the same period. XLRE invested almost 27 percent in residential, retail and hospitality REITs.

Office & commercial REITs were the worst of the lot, followed by the healthcare REITs. Equinix Inc. (EQIX) fell by 14 percent, CBRE Group Inc. (CBRE) lost 17 percent, Boston Properties Inc. (BXP) lost 21 percent, Ventas Inc. (VTR) fell by 13 percent, Healthpeak Properties Inc. (PEAK) lost by 22 percent, and Alexandria Real Estate Equities Inc. (ARE) recorded a negative price growth of 22.5 percent during the past one year. Only Welltower (WELL) was able to record a marginal positive growth. All these firms constitute 20 percent of XLRE's portfolio.

It is quite clear where the growth lies - in industrial REITs:

Over the past decade, one of the biggest beneficiaries of the growth of e-commerce is industrial REITs. With a growing number of consumers shopping online, e-commerce companies are setting up warehouses and fulfillment centers near metropolitan areas where a majority of customers live... These strategic industrial properties will deliver steady growth for a longer period as they are in a better position to facilitate the movement of goods to and from manufacturers, distributors, fulfillment centers and the end consumers.

At the same time, we can figure out where not to invest under present circumstances - that is Office & commercial REITs and Healthcare REITs. Post covid-19 pandemic, remote work has become a permanent feature.

"I think remote work is going to be a permanent feature," Jonathan Litt, founder and chief investment officer of Land and Buildings, a real estate activist hedge fund, said on Yahoo Finance Live. "I think there's going to be a real struggle for traditional landlords."

Traditional landlords are facing real struggle due to lack of occupancy. Companies with older office buildings are suffering the most, as their rents are going down and expenses are going up. The inflation and looming recession is adding more pain to them.

Post-pandemic healthcare REITs are also facing revenue pressure and occupancy issues. However not all the healthcare REITs are in trouble. REITs focused on skilled nursing facilities (SNF) and senior housing operated portfolios (SHOP) are facing these problems much more than the REITs focused on medical office buildings (MOB), hospitals, and outpatient/ physician facilities. Unfortunately, WELL, PEAK, and VTR, all these three major healthcare REITs have a high focus on SNF and SHOP segments.

Overall, three fourth of the fund had negative growth over the past one year, and within that almost 20 percent had high negative growth in the range of 13 percent to 22.5 percent. As DRN invests in derivatives of all these REITs, and invests thrice the volume, this 3x leveraged ETF is expected to generate a much higher loss over the same time horizon. Quite expectedly, DRN suffered huge losses over the past one year (29 percent), and also in 2022 (48 percent). However, during the last week, DRN was able to record a return in excess of 20 percent, which I feel is a short term phenomenon.

We can get an idea of how the benchmark index performed and will perform in the coming months, with the help of another fully diversified real estate fund like Fidelity MSCI Real Estate Index ETF (FREL). While analyzing FREL, I found that "certain uncontrollable factors like pandemic, inflation, and looming recession have impacted this fund and the overall REIT sector significantly. Only the industrial REITs have been able to grow during the past one year, and in case there is a rescission, only these REITs are expected to grow." Going by the trend, it's quite unlikely that as a leveraged bull fund concentrated more on other forms of REITs, DRN will be able to generate huge positive growth.

One interesting point to note is that DRN pays quarterly dividends, which most leveraged ETFs don't do. However, historically the payout was inconsistent and yield was low. The yield seems high (in excess of 6 percent) in 2020 and at present, only due to low prices. Otherwise the historical yield had been below 2 percent, and was almost zero during the five year period of 2013 - 2017. In absence of positive growth, such yield doesn't become a determining factor to the investors. So, ultimately, the composition and performance of the underlying index matters.

It's not that DRN made losses and will suffer due to its exposure in the real estate sector, but due to the composition of its portfolio.

In a scenario of rising inflation, REITs are generally a good bet. However, investors are required to be selective regarding the kind of properties those REITs possess. REITs which are less impacted by recession and in which tenants sign long-term leases, like industrial REITs, are expected to perform better than specialized, retail, and healthcare REITs. On the other hand, investors need to stay away particularly from office REITs.

Moreover, as this fund invests in derivatives, three times the volume of those stocks, the loss gets compounded.

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