Reasons To Consider REIT ETFs

Real estate investment trusts (REITs) and the corresponding exchange-traded funds faced a trying environment in 2015, as investors anticipated the Federal Reserve's first interest rate increase in nearly a decade, but that environment has rapidly changed in 2016 as investors' search for safe-haven assets has sent Treasury yields tumbling.

With above-average yields being one of the primary reasons income investors turn to REITs, it is notable that the asset class is participating in the recent dividend growth seen throughout the broader financial services sector. Real estate stocks will be classified as financial services names until late August when real estate separates into the eleventh S&P 500 sector.

Ebbing Treasury yields have helped benchmark REIT ETFs perform notably less poorly than broader financial services ETFs this year. For example, the Vanguard REIT Index Fund (NYSE:VNQ), the largest real estate ETF by assets, is off 5.4 percent a loss that is about 400 basis points less bad than the S&P 500 and about half the loss incurred by the largest diversified financial services ETF.

Despite the funds poor performance, investors have continued to pour money into the asset class with the trend accelerating in the current market. While the first half of last year saw investors pull $2.1 billion from the fund; these outflows were more than reversed in the second half as investors ploughed $2.9 billion into the fund. VNQ has seen $800 million of inflows so far in January, the most in over 13 months, said Markit in a recent note.

A Closer Look At VNQ

VNQ is home to 152 stocks, nearly a quarter of which are retail REITs. Another 14.8 percent are specialized REITs, 17.1 percent are residential REITs and 13.7 percent are office REITs. VNQ's top 10 holdings, which combined for over 37 percent of the ETF's weight at the end of December, include Simon Property Group Inc (NYSE:SPG) and Public Storage (NYSE:PSA).

REITs And Interest Rates

Historical data suggest REITs perform worst immediately following higher rates are announced, but once markets adjust to the announcement, REITs actually perform well for months after the initial rate hike. That could be one reason why investors have recently been putting new capital to work with REIT ETFs.

VNQ's constituents have also come under pressure as average shorting activity (as tracked by the percentage of shares out on loan) has surged in the REITs that currently make up VNQ. Current demand to borrow the funds constituents now stands at 2.8 percent of shares outstanding, levels not seen since the end of 2014, said Markit.

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