The U.S. Real Estate Investment Trust (REIT) industry has carved
a niche for itself and is now an important part of the overall
economy. Amid the low interest rate environment following the
financial crisis, the demand for REITs has risen owing to their
ability to deliver steady income. Moreover, they help investors
benefit from their capital appreciation opportunities as well (Real
Estate ETFs: Unexpected Safe Haven).
Though the economic uncertainty and particularly the political
situation have been major factors impacting the market, we believe
that with the economic recovery gaining momentum, rents and
occupancies for most types of properties would improve further.
In fact, it has been noticed that the residential real estate
market has improved and commercial real estate prices are also
increasing. And with more jobs in the economy, the sector should
experience increasing rents and higher occupancy.
Additionally, in the Apartment sector there have been
improvements, yet minor hiccups remain with an increase in supply
in certain markets. The Industrial sector is projected to benefit
from the improving economy while the Timber sector’s performance
would gain from an increase in new construction. In a nutshell, the
long-term prospects of the REIT industry look favorable.
A combination of factors has helped the REIT sector stand out
and gain a strong foothold over the past 15 to 20 years, the most
notable among them being a healthy dividend payout. As a matter of
fact, investors looking for high dividend yields have historically
favored REIT stocks (4 Excellent Dividend ETFs for Income and
Stability).
In fact, solid dividend payouts are arguably the biggest
enticement for REIT investors as U.S. law requires REITs to
distribute 90% of their annual taxable income in the form of
dividends to shareholders (in order to maintain certain tax
advantages).
In addition, REITs typically have a large unencumbered pool of
assets, which could provide an additional avenue to raise cash
during a crisis. These assets, in turn, have provided the requisite
resources to the REIT industry to make strategic acquisitions over
time to fuel its inorganic growth engine.
Going forward, we believe M&A opportunities will increase in
the current low interest rate environment. Particularly the REITs
with a solid balance sheet and reasonably better accessibility to
capital are expected to capitalize on such opportunities.
ETFs in Focus
In order to capitalize on these encouraging trends in the U.S.
REIT industry, the ETF world has in its offering quite a few funds.
Vanguard REIT ETF
(VNQ), iShares
Dow Jones U.S. Real Estate Index Fund
(IYR) and SPDR
Dow Jones REIT ETF (RWR)
are some of the popular names in this space.
While these represent some of the common ways to target the U.S.
REIT industry, there are still many others which have been strong
performers this year. In this article, we would like to focus on
two that have been designed to provide exposure to the small cap
segment of the industry and are usually overlooked by
investors.
Why Small Cap REIT Stocks?
As the real estate market recovers, small cap real estate ETFs
are poised to benefit enormously from the current market
environment, implying that they could continue to outperform their
large cap counterparts as the year progresses.
This is because small caps are less vulnerable to global trends,
tend to do better on average in rising markets, and can potentially
offer a different sector mix than their large cap peers in changing
markets (Small Cap Real Estate ETFs: Crushing The Competition).
On the other hand, large caps are multinational firms that are
highly exposed to international markets and economic volatility. As
large cap firms have already reached their maturation, they have
little ability to expand further, thereby returning less.
Hence, small cap real estate ETFs could be considered the best
option for investors seeking to play in the current real estate
market. Further, small cap real estate ETFs often pay outstanding
dividends when compared to other large cap counterparts, suggesting
that they could be excellent picks from this view as well.
PowerShares KBW Premium Yield Equity REIT Portfolio
(KBWY)
As the name suggests, KBWY follows the KBW Premium Yield Equity
REIT Index. With its main focus on small and mid cap REIT
securities, the fund seeks to provide exposure to a small basket of
34 securities (3 Excellent REIT ETFs You Should Not Ignore).
Despite the narrow exposure, the fund does not appear to be
concentrated in the top ten holdings. The top ten holdings have a
share of 36.25% in the fund.
The fund manages an asset base of $89.3 million and appears to
be light on volume at just 21,900 shares a day. KBWY charges
investors a fee of 35 basis points annually and generates a yield
of 4.82% in the process.
The fund has been a strong performer providing a gain of
20.28% in the year-to-date period. So, apart from investing in the
usual suspects, investors can also opt to invest in this fund and
gain higher returns as well.
IQ US Real Estate Small Cap ETF
(ROOF)
ROOF seeks to replicate the performance of the IQ US Real Estate
Small Cap Index, which is a float adjusted market cap weighted
index. The fund manages an asset base of $51.8 million.
However, the fund is less liquid as it trades only 31,500 shares
per day on average. This illiquid nature of the fund might raise
the liquidity cost in the form of a wide bid/ask spread.
Though the product charges a higher fee of 69 bps per annum from
investors, it yields about 3.37% in annual dividend and has
returned 18.51% year to date (Three Great ETFs to Buy This Earnings
Season).
The ETF is widely spread across several real estate markets —
mortgage REITs, office REITs, retail REITs, specialized REITs,
hotel REITs, diversified REITs and residential REITs.
Not only does the fund have a wide exposure to different REITs,
it also has large diversification benefits with respect to
individual holdings. With a basket of 55 securities, ROOF allocates
about 37% in the top 10 holdings, with no more than 4.6% in any one
firm.
Investors should also note that this product is more heavily
tilted towards value and mid caps suggesting that for investors
looking to go beyond large caps, this product could be an
interesting pick.
Bottom Line
To sum up, we firmly believe that, given the current recovery of
the economy as well as the low interest-rate environment, REITs
still offer a worthy investment proposition for 2013.
Additionally, history reveals that small cap real estate can be
a solid pick when markets are rebounding. And even when the sector
is seeing some weakness, its outsized yield is likely to help
soothe investor worries and make ROOF and KBWY a great pick no
matter what the market conditions are.
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ISHARS-DJ REAL (IYR): ETF Research Reports
PWRSH-K PY REIT (KBWY): ETF Research Reports
IQ-US RE SC (ROOF): ETF Research Reports
SPDR-DJ W REIT (RWR): ETF Research Reports
VIPERS-REIT (VNQ): ETF Research Reports
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