REIT ETFs as a Diversification Tool during Challenging Times
- October 14, 2016
By ETF Heat Map Team
Real estate investments trusts (REITs), and their respective corresponding ETFs, are traditionally viewed as an attractive alternative asset class that provides investors with consistent dividend payments, high yields, a lower correlation to the equity market indexes, and exposure to asset managers that operate physical underlying commercial and retail properties (real estate businesses) in markets across the world. The market for REITs has increased globally from approximately $9 billion (USD) to over $1 trillion over the past 25 years. REIT ETFs are a wonderful way to gain exposure to the REIT sector.
A research report issued by Citi Research at the end of September 2016 indicated that approximately $22.5 billion flowed into REITs so far this year; however, the expect reason for this inflow into REITs related financial instruments is unknown and some speculate that it may be the caused by the low interest rate environment that is negatively impacting many other fixed income securities. An interesting fact about REITs remains that most of these trusts pay out “approximately 90% of their net taxable income in the form of dividends.” While outstanding fixed income instruments and contracts worth $12 trillion globally are trading at negative yield to maturity, REITs and REIT ETFs seem like an attractive alternative solution to calm investor woes.
It is difficult to predict the future of the real estate market around the world. Many investors share the opinion that real estate in parts of North America might be temporarily overvalued and that real estate investors should remain cautious after sudden price increases in the real estate market over the last 2 years. Some investors look at China’s real estate development projects as a very large bubble that will eventually deflate forcing existing market prices for apartments and homes to come down. It seems that valuations and appraisals of residential homes, condos, and apartments have become more bearish as of recent in many of the hot markets around the globe.
One perspective is that the prolonged low interest rate environment and the fear of rising rates in the future created a short term market frenzy in the last few years that resulted in investors and home owners competing frantically that resulted in the bidding up of real estate prices. People were able to take on larger mortgages at low historically low fixed rates. The cost to borrow cash became cheap and investors were not shy to take on excessive long term debts and risk in order to invest in their dream real estate projects.
Over the medium to long term, it will be interesting to see if the real estate markets retain their value. There are many wonderful reasons behind why real estate makes a wonderful investment and should remain part of every investment portfolio. However, it seems that drastic recent price increases have made some real estate momentarily unattractive. It seems that investors have become extremely cautious thus reducing the demand for real estate in a global economy that has slowed down over recent years and is witnessing lower growth forecasts.
However, there is an alternative view that says that investment into commercial and retail investment projects might still be profitable if investors can identify mispriced assets.
Instead of investing purely in individual real estate projects which might be purely residential, commercial or retail, it makes more sense for investors to consider investing in real estate related ETFs that provide them with a greater level of diversification. Investors can also choose to invest in lower denominations or ETF shares instead of having to physically buy the whole real estate asset by themselves.
The Tierra XP Latin America Real Estate ETF, with trading symbol LARE, is operated by Tierra Funds and provides investors regional growth and attractive income exposure to Latin America. The LARE ETF is worth exploring further because the LARE ETF tracks the Solactive Latin America Real Estate Index, and is less correlated to the S&P 500 equity index when compared to comparable U.S. REIT ETFs.
As stated by Tierra Funds, “The Solactive Latin America Real Estate Index screens for all listed equities with primary listings in the Latin America region and which derive substantially most of their income from real estate and real estate services. The Index then uses dividend yield, market capitalization and liquidity in the underlying shares to determine weights. The Index is rebalanced quarterly.”
REIT ETFs do provide investors with a good diversification opportunity in an alternative asset class. However, investors should conduct their own due diligence, consider the value of the underlying real estate assets, and growth potential before determining the best time to enter the market.