Revisiting Real Estate ETFs

When taking into account the challenges presented by the Federal Reserve's interest rate tightening cycle, the real estate sector and the related exchange traded funds have been alright in 2018.

The Vanguard Real Estate ETF VNQ, the largest ETF dedicated to the sector, is up 1.7 percent year-to-date, well ahead of a 0.3 percent gain for the S&P 500.

What Happened

VNQ and rival real estate ETFs could be part of the move to defensive sectors, a trend that's becoming increasingly apparent amid elevated market volatility. Data suggest real estate ETFs can provide some refuge from volatility. On a year-to-date basis, VNQ's annualized volatility is 100 basis points below the S&P 500's.

Real estate is among the defensive sectors CFRA Research recently upgraded. The research firm lifted its rating on the sector to Marketweight from Underweight.

Why It's Important

“CFRA thinks the pace of interest rate increases over the next twelve months is likely to moderate along with inflation,” said CFRA's Director of ETF & Mutual Fund Research Todd Rosenbluth in a Monday note. “The Federal Reserve is slated to raise the fed-funds rate once more this year, for its fourth rate hike in 2018, but the pace of rate hikes in 2019 will slow as the Fed becomes more data dependent.”

The research firm has Buy or Strong Buy ratings on 20 domestic real estate stocks, or 31 percent of its coverage universe for that sector. Within the real estate investment trust space, industrial REITs are among the more appealing groups. VNQ allocates 6.4 percent of its weight to industrial REITs while the rival Schwab U.S. REIT ETF SCHH features a 9.5 percent industrial REIT allocation.

“CFRA Equity Analyst Chris Kuiper, CFA thinks this REIT sub-industry benefits as the growth of e-commerce provides a supply-demand imbalance for the logistics space close to metropolitan centers,” said Rosenbluth.

What's Next

VNQ has $30.1 billion in assets under management, making it more than six times larger than SCHH, but the Schwab ETF is slightly cheaper with an annual fee of 0.07 percent, or $7 on a $10,000 investment. VNQ charges 0.12 percent.

CFRA has Overweight ratings on both ETFs.

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