REITs Soar into Storm Clouds


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In mid-2009 we asked whether real estate investment trust ETFs had priced in a predicted tidal wave of commercial real estate foreclosures. We concluded prices had fallen so far they could well be at fair market value.

Those prices were fair indeed. REITs have nearly doubled in the past year. How did they do it? On the one hand, investors flocked to their steady dividends which compare favorably to anemic bond yields. On the other hand, REITs were able to shed problem properties and grab properties at distressed prices, heightening their appeal.

Major broad market REITs all gained ground:

The funds above are iShares Cohen & Steers Realty Majors ETF (NYSEArca:ICF) at 0.35% fees and iShares Dow Jones US Real Estate ETF (NYSEArca: IYR) at 0.48% Vanguard REIT ETF ( VNQ ) with a phenomenal 0.12% annual expense ratio.

Despite stellar recent returns, economic fundamentals for the industry remain precarious. According to a report by the Congressional Oversight Panel, commercial property values have fallen 40 percent on average since 2007. Over $1.4 trillion in commercial loans will come up for refinancing by 2014, and nearly half of those are underwater, according to the report. Vacancy rates range from eight percent for multifamily housing to 18 percent for office buildings. Owners have scrambled to fill space by dropping rents 40 percent for office space and 33 percent for retail space. Wall St. creations could fare the worst. Deutsche Bank estimates that two thirds of commercial mortgage-backed securities will fail to roll over in the next few years.

Banks will no doubt ask for more equity from owners at refinancing time, but commercial owners will not hesitate to walk away if pressed too hard. If they walk in sufficient numbers, more fire sale pricing will follow. Nor are cheap Federal Reserve funds rates helping. Banks are charging hefty spreads over Fed rates to help recoup losses. With higher carrying costs, property buyers must lower their offers.

The healthiest REITs are reinventing themselves as distressed asset funds by raising more cash. This has attracted institutional and high net worth investors eager to get in at the bottom of the cycle. REITs almost look like hedge funds with good prospects, transparency, and low fees. Inflation, if it comes on the heels of interest rate hikes, should work to REITs' favor. If the dollar devalues, hard assets will increase in dollar terms.

A long-term view of REITs is valuable. It shows how the asset class is now back to five-year old valutations and illustrates just how big the bubble was:

Other broad market US REIT ETFs include:

  • iShares FTSE EPRA/NAREIT North America ETF (NasdaqGM:IFNA); 0.48% annual fees
  • First Trust S&P REIT ETF ( FRI ); 0.70% fees
  • iShares FTSE NAREIT Real Estate 50 ETF (NYSEArca:FTY); 0.48%

Picking the right sub-sector clearly can make a difference. Sub-sector ETFs of the above chart include:

  • iShares FTSE NAREIT Industrial/Office ETF (NYSEArca:FIO); 0.48% annual fees
  • iShares FTSE NAREIT Mortgage ETF (NYSEArca:REM); 0.48%
  • iShares FTSE NAREIT Residential ETF (NYSEArca: REZ); 0.48%
  • iShares FTSE NAREIT Retail ETF (NYSEArca:RTL) ;0.48%

Going international is attractive at times because it dampens volatility and protects against dollar devaluation. Choices include:

  • First Trust FTSE EPRA/NAREIT Global Real Estate ETF (NYSEArca:FFR); 0.6% annual fees
  • iShares FTSE EPRA/NAREIT Asia ETF (NasdaqGM:IFAS); 0.5% fees
  • iShares FTSE EPRA/NAREIT Europe ETF (NasdaqGM:IFEU) 0.48% fees
  • iShares FTSE EPRA/NAREIT Global Real Estate ex-US ETF (NasdaqGM:IFGL); 0.48% fees
  • iShares S&P World ex-US Property ETF (NYSEArca:WPS); 0.48% fees
  • WisdomTree International Real Estate ETF ( DRW ); 0.58%

While not a REIT ETF, PowerShares Dynamic Building & Construction Portfolio ETF ( PKB ), which contains mostly firms serving the housing industry though no actual builders.

Two interesting trader's tools are expected in Q2 of 2009:

  • MacroShares Major Metro Housing Down ETF (NYSEArca:DMM); 1.25% fees
  • MacroShares Major Metro Housing Up ETF (NYSEArca:UMM); 1.25%

They track S&P/Case-Shiller Indexes of residential housing in 10 major US metro areas.

Investors who want to add an active element to their strategy should look to PowerShares Active U.S. Real Estate ETF (NYSEArca:PSR), costing 0.8% in annual fees. PSR uses quantitative and statistical models to try to beat the FTSE NAREIT Equity REITs Index, and it generally makes changes once a month. This is basically the same as a fundamental, semi-active, or intelligent ETF and is worlds away from subjective individual stockpicking.

Finally, traders can make directional, leveraged short-term bets on REITs with:

  • ProShares Ultra Real Estate ETF ( URE ); 0.95% annual fees
  • ProShares UltraShort Real Estate ETF (SRS); 0.95% fees

Co-founder of, author of two books on investing, and founder of, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing ETFs
Referenced Stocks: DRW , FRI , PKB , URE , VNQ

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