A deep gloom overhangs the U.S. real estate market. Shopping malls dark, pools algaed, McMansions abandoned. Yale University professor Robert Shiller, who rightly called US property a bubble five years ago, continues to predict prices will fall even more. But, where tenured academics see disaster, savvy investors see opportunity, especially in commercial property.
Companies like Vornado Realty (VNO-US), which owns retail and office buildings in New York, Washington D.C. and Chicago, took advantage of the bargain prices and low interest rates of the last few years to acquire quality properties. Another company is Simon Properties (SPG-US), the biggest owner of premium malls in the United States.
Generally, U.S. commercial real estate prices are suffering. The latest valuations – according to Moodys/REAL Commercial Property Price Index – show prices for U.S. retail, industrial, apartment and office buildings have fallen on average by half from their mid-2007 high and are back at 2001 levels. Yet that average Index masks significant disparities based on location, sector and quality.
True, prices of industrial sites, especially in Middle America, are languishing near their 2001 levels. But retail – as Vornado and Simon will attest to – has been one of the best performing sub-sectors. Another is apartment buildings, especially “trophy buildings”. Something like a 6-star apartment fronting Central Park. Both apartment and retail sub-sectors, though still below their 2007 peak, are up a respectable 30% from 2001. And that too with moribund economic growth.
Share prices for REITs – property companies that pay out 90% of their taxable income as dividends – have also risen. Vornado trades at about $97, below its 2007 peak at $134 but triple the $33 it hit after property crashed. Simon’s shares have done even better having recovered completely from the crash and trade at $121.
After that kind of rally, can REIT shares keep outperforming the broader market? Much like the commercial property, it depends on which sector.
REITs like Vornado and Simon seem to be fully valued, though they may have some room to rise further if property prices start rising faster. That 30% since 2001 works out to less than 3% a year, just enough to keep up with long-term inflation.
There is likely more scope for increases in REITs holding unloved industrial and mid-western properties. DCT Industrial Trust (DCT-US) trades at about $5.50, half its 2007 level. First Industrial (FR-US) trades at $12, versus its $50 price in 2007.
Assuming even a 4% annual growth rate in prices – inflation plus about 1 to 2 percentage points – property prices should be significantly higher than where they are now. DCT and its peers will benefit as prices begin to rise in line with their historic norms.
While it could be very profitable to choose from among the REITs, it would be safer, simpler and still profitable to buy an exchange-traded fund of REITs. The best such is Vanguard’s REIT ETF (VNQ-US). With over $20 billion in assets under management, it is the largest in its category. It holds 105 U.S. REITs cover the entire U.S. commercial market, both regionally and by sub-sector. It holds winners
like Simon and Vornado who will continue to perform. It holds losers like DCT and First Industrial who offer more potential gains. Best of all, its annual fee is just 0.12% or $12 per $10,000.
VNQ has outperformed the broad equity market since 2009. Year-to-date VNQ is up about 12%, compared to about 6.3% for the iShares S&P 500 ETF (IVV-US). VNQ’s dividend yield is 3.08% versus 1.73% for IVV.
But that comes at a price. VNQ’ share price has a volatility – around 47% annualized – that is more than double that of IVV. Its beta – a measure of how much VNQ’s price moves relative to the market – is about 1.5 times. Both these factors have to do with the leverage that is inherent in the property business. Put 20% down and borrow the rest. This makes for quick profits when interest rates are low and property prices are rising. It can make for even quicker ruin when interest rates rise and property eases off. All the more reason to stick with a diversified ETF versus selecting single REITs.
|Benchmark||MSCI US REIT Index|
|52 Week High||$62.15|
|52 Week Low||$44.96|
|Avg Daily Volume||1.76 Million Shrs|
|Avg Daily Volume ($)||$109.28 Million|
|Total Market Cap||$20.94 Billion|
|ETF Annual Fee||0.12%|
|ETF Trading Currency||USD|
|ETF FX Exposure||USD|
|Correlation to S&P 500||76.6%|
|Return to Risk Ratio||0.32|
|Use of Leverage||No in ETF but yes in holdings.|
|Use of Futures||No|
|6 month Return||14.63%|
|1 Year Return||38.03%|
|2 Year Return||127.24%|
|3 Year Return||27.28%|
|Dividend Yield (TTM)||3.17%|
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© 2011 archerETF Portfolio Management is a division of Bellwether Investment Management, a discretionary portfolio manager registered with the Ontario Securities Commission. This report is provided for information only and does not constitute investment advice. While we believe the information to be accurate and timely, we make no claim or warranty to that effect. Please seek professional advice before making any investment decision. We may hold positions in any or all securities discussed in this report.