Amid elevated Treasury yields and little clarity as to when the Federal Reserve will commence reducing interest rates, it’s been a rough year for real estate investment trusts (REITs) and related exchange traded funds. Just look at the S&P Real Estate Select Sector Index, which is trailing the S&P 500 by a wide margin.
More recently, the tide has been turning in favor of REITs. The Real Estate Select Sector Index is higher by 8.40% over the past month, and that could be one sign that ETFs such as the VanEck Office and Commercial REIT ETF (DESK ) could be worth considering with 2024 right around the corner.
DESK debuted in September and follows the MarketVector US Listed Office and Commercial REITs Index. As the fund’s name and that of the index imply, the emphasis here is commercial and office REITs – corners of the real estate sector that have encountered headwinds, but could also offer rebound potential in 2024.
Drilling Down on This REIT ETF Opportunity
As noted above, REITs, including DESK holdings, have been hindered by high interest rates. That’s because REITs are capital-intensive enterprises and often carry large amounts of debt, but the debt outlook for these firms may be better than some market participants believe it to be.
At the end of the third quarter, 91% of debt held by REITs was in fixed rate form and “leverage ratios remained modest with debt-to-market assets at 36.2%,” according to Nareit. The research firm added that the weighted average interest rate on REIT debt was manageable and the weighted average maturity on those obligations is 6.5 years, indicating many DESK member firms aren’t dealing with imminent maturities.
Other data points, though applicable to the broader REIT space, could augur well for DESK going forward. Notably, as of the third quarter, two-thirds of REITs reported year-over-year increases in funds from operations (FFO), noted Nareit. FFO is a crucial metric in valuing REITs because it provides investors with insight as to a REITs’ ability to cover and grow its dividends. After all, income is one of the primary reasons market participants embrace this asset class.
At the end of September, the average cap rate for office REITs was 7.71%. There’s some debate, but most analysts view cap rates of 4% to 10% as “good.” Additionally, higher cap rates imply added risk, but the potential for greater reward indicates DESK could be a solid idea for risk-tolerant real estate investors.
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