New Supply Finds Its Way Into REIT ETFs

Although 10-year Treasury yields are up just 4.5 percent year-to-date, 2015 has been a trying year for real estate investment trusts (REITs) and the corresponding exchange-traded funds because investors have been fretting over the Federal Reserve raising interest rates, something that could happen as early as this week.

REITs And REIT ETFs

The Vanguard REIT Index Fund VNQ, the largest REIT ETF, and the iShares Dow Jones US Real Estate (ETF) IYR are off an average of 3 percent this year, while broader financial services ETFs have posted modest gains.

Related Link: Hey, At Least REIT ETFs Deliver Dividend Growth

REITs and REIT ETFs are rate-sensitive, just as their utility, preferred stock and master limited partnership peers are. However, a case can be made that economic growth is not only supportive of a rate hike, but for more upside in REIT ETFs as well. Plus, investors are compensated for taking REIT risk in the form of dividend growth.

Additionally, REIT ETFs have absorbed a spate of new supply this year. Recently, Dow component McDonald's Corporation MCD quashed plans for a REIT offering, but MGM Resorts International MGM is moving forward with a similar plan.

“In a recent SNL Financial article on the top 25 institutional holders of REITs, Imran Tahir noted that BlackRock Fund Advisors, which manages iShares ETFs, and SSGA had three additional REIT positions in the third quarter,” said S&P Capital IQ in a note out Tuesday.

“One such holding was Four Corners Property Trust Inc FCPT, a recent spinoff from Darden Restaurants, Inc. DRI. FCPT owns the real estate associated with 424 restaurants, nearly all which will be leased back to Darden subsidiaries through triple-net leases with 15-year initial terms on average.”

Still, rising rates loom large for REITs and the relevant ETFs. For example, recent short sales data indicate IYR was one of the most borrowed ETFs by short sellers last week, as traders prepared for this week's Fed meeting.

Historical Performance Of REITs And Higher Rates

However, historical data suggest REITs perform worst immediately higher rates are announced and once markets adjust to the announcement, REITs actually perform well months after the initial rate hike. That could be one reason why investors have recently been putting new capital to work with REIT ETFs.

“While REIT stocks have been out of favor in 2015, investors have put fresh money into REIT ETFs that hold such stocks. Even as selling occurred this year in dividend focused sub-industries, such as diversified REITs, office REITs and retail REITs, ahead of the Federal Reserve's likely rate hike, REIT ETFs added $1.6 billion of fresh assets year to date through November. More than half of the assets hit the ETFs last month according to SSGA data,” said S&P Capital IQ.