REIT ETFs Gain On Interest Rate Tumble

Falling interest rates have been a big theme all year on Wall Street and contributed to the resurgence of bonds, utilities and real estate investment trusts (REITs).

This week, the 10-Year Treasury Note Yield hit a new year-to-date low of 2.29 percent, sparking a strong rally in these favored asset classes.

The Vanguard REIT ETF VNQ has gained 2.19 percent in the month of October and 16.61 percent so far in 2014.  This ETF tracks 138 real estate stocks that include holdings in hotels, office space, retail, residential and other real property assets. 

REITs are typically an interest-rate sensitive asset class because they derive greater profits when bond yields are falling and financing costs become cheaper.  They are also reactive to real property price cycles, which often lead to higher or lower rental income.

One of the benefits of owning REITs are the above-average income streams that are produced as a result of rental income produced from their properties.  VNQ has an effective yield of 3.64 percent and charges a miniscule expense ratio of 0.10 percent.

While a diversified REIT may be appealing for broad-based exposure to this sector, specific niche markets may offer stronger returns based on their underlying index allocation.    

This year, the iShares Residential Real Estate Capped ETF REZ is leading the real estate sector with a total return of nearly 20 percent.  REZ offers more focused exposure to just 36 REITs that are involved in residential properties.

This includes top holdings such as Public Storage PSA and Equity Residential EQR, which both make up 10 percent of the REZ portfolio. 

The big test for the strong momentum in these REIT ETFs will be how they cope with the next interest rate tightening cycle.  The release of the Federal Reserve meeting minutes this week seemed to indicate that economic forces preclude that event until next year. 

For the moment, these income-oriented ETFs are enjoying the era of low rates and healthy returns. 

Disclosure: At the time of this writing, the author held a position in VNQ.