Real Estate ETFs Continue To Soar

Real estate ETFs have been moving like a stealth bomber under the radar for the first three months of the year and continue to notch new 2014 highs.  The combination of stabilizing interest rates and low equity issuance has been a tailwind for publicly traded REITs that are coming off a volatile 2013.  In addition, we are continuing to see positive signs of increasing real estate prices that make this sector both a growth and income play moving forward.

The largest ETF in this space is the Vanguard REIT ETF (VNQ) which tracks a diversified portfolio of more than 130 publicly traded commercial and residential REITs.  The top three holdings in VNQ include: Simon Property Group (SPG), Public Storage (PSA), and Prologis Inc (PLD).  In addition, this ETF offers a 30-day SEC yield of 3.83 percent and charges a rock-bottom annual expense ratio of just 0.10 percent. 

So far this year, VNQ has gained over 11 percent and continues to signal that the uptrend is showing no signs of slowing down.  When compared to the flat returns and meager 1.80 percent yield of the SPDR S&P 500 ETF (SPY) over the same time frame, you can easily see how much this sector has outperformed in 2014.

Aggressive income seekers in the real estate sector are also likely to be drawn to mortgage REITs which have been on a strong run over the last several months as well.  The iShares Mortgage REIT Capped ETF (REM) has a 30-day SEC yield of 10.94 percent that is near the top of its class for equity-income funds. 

Mortgage REITs tend to be highly sensitive to any swift move in bond yields because they borrow short-term money very cheap and use it to buy long-term debt.  This enables them to pocket the spread on interest rates and distribute the majority of earnings to shareholders.  In addition, they use excessive leverage to juice their returns which in turn makes them more responsive to changes in rates.

The biggest risk to the real estate sector moving forward is the threat of an additional push higher in interest rates which would act as a headwind for further upside.  However, further positive economic data coupled with additional demand in real estate prices would likely lift these ETFs even higher.