Is the Time REIT for Real Estate ETFs?

by on May 21, 2009 | Updated May 26, 2009 | ETFs Mentioned:

As a result of the seemingly endless decline in the U.S. housing market (we’re nearing the three year mark for the current downturn), most real estate ETFs on the market have been posted huge losses since 2007, with many still down more than 50% from their record highs despite recent rallies. But as any shrewd investor knows, crisis begets opportunity. With real estate ETFs reaching new lows, the time may finally be right to snatch up some funds at bargain prices.

Signs of Hope…?

After bottoming out earlier this year, many real estate ETFs have staged modest rallies in recent months, but many remain well below their 52-week highs and even further from levels seen prior to 2008. Despite the recent rallies, there are several reasons why real estate ETFs may continue to rise over the summer months.

  • Rising Home Prices: After years of continuous declines, home prices in several major markets, including San Diego, Houston, and Phoenix, are finally reversing course and heading upwards once again.
  • Stabilizing Unemployment Rates: While housing statistics get the most attention, residential property typically only accounts for 10% – 20% of diversified REIT portfolios, with the vast majority of investments focusing on commercial and industrial properties. Although unemployment increased further in April, the pace of job losses has slowed considerably, providing hope that the job market is close to bottoming out. Unemployment data is critical to the commercial real estate market since it impacts commercial vacancy rates. Many analysts project vacancy rates to soar above 20% from the current level in the mid-teens. If unemployment reverses course over the summer, however, there could be a surprise on the upside.
  • Improving Consumer Confidence: Since retail properties also comprise a large portion of REIT holdings (shopping malls, big box retailers, etc.), consumer confidence is an important indicator when evaluating a potential investment in real estate. The Conference Board reported that consumer confidence, a closely watched economic indicator, increased by 12 points in April to 39.2, the highest reading since November. Given the psychological element of real estate activity, a rise in consumer confidence could result in further price increases.

…Or Just a Mirage?

Before you get too optimistic, there’s plenty of bad news to consider as well:

  • Construction Slows: Construction of homes and apartments fell to a seasonally adjusted rate of 458,000 in April, the lowest pace in nearly 50 years.
  • Vacancy Rates TBD: Although job losses slowed last month, the fact remains that more than 6 million jobs have been lost since the start of the current recession. Since many companies lack complete flexibility with their office space needs, there is the fear that tenants will sign smaller office areas when current deals expire, causing vacancy rates to skyrocket and placing downward pressure on commercial rent rates.
  • Weak Commercial Activity: The National Association of Realtors reported recently that the U.S. commercial real estate sector declined in the first quarter of 2009, with brokerage activities falling 4.8% from thr fourth quarter of 2008.

Overall, uncertainty about the sustainability of recent positive developments continues to weigh on real estate ETFs. If these gains reverse, we could see real estate investments plunge again. But if we have indeed bottomed out, real estate ETFs are worth keeping an eye on in the coming months.

Abundance of Options

For those who believe the real estate market is poised for a comeback, there are several options that provide market exposure. A few of these funds are highlighted here:

  • Vanguard REIT ETF (VNQ): This ETF is designed to track the performance of the MSCI U.S. REIT Index, a benchmark of U.S. property trusts that covers about two-thirds of the U.S. REIT market.
  • iShares Dow Jones U.S. Real Estate Index (IYR): IYR tracks the diversified Dow Jones U.S. Real Estate Index. This index holds a number of REITs with interests in a wide variety of real property, including shopping malls, storage facilities, residential properties, and timber.
  • SPDR DJ Wilshire International Real Estate (RWX): This State Street fund offers exposure to real estate markets throughout the world. In addition to U.S. real estate (43% of fund holdings), IYR holds assets in Japan (12%), Australia (8%), and the UK (8%). RWX has outperformed the majority of U.S.-only real estate ETFs over the past year.
  • ProShares Ultra Real Estate (URE): URE is a leveraged ETF, meaning that it is generally inappropriate for buy-and-hold investors and is primarily used by day traders. For sophisticated investors looking to generate a quick intraday profit, URE may be a useful tool. Given the frequency with which important real estate related information is released (new construction, unemployment data, etc.) real estate indices often experience significant one-day movements that can be exacerbated with leveraged funds.