Taking a Step Back From REIT ETFs Following Fed Stance

Buoyed by the Federal Reserve’s lower for longer stance on interest rates and investors’ seemingly unquenchable desire for income, real estate investment trusts (REITs) and the corresponding exchange traded funds are among this year’s most popular income-generating asset classes.

The Vanguard REIT ETF (NYSEArca: VNQ), SPDR Dow Jones REIT ETF (NYSEArca: RWR) and iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) are among the most popular REIT ETF plays. While these are some of the top-performing sector funds this year, some industry observers and technical analysts believe the group can keep soaring.

Some market observers believe REITs will see increased after becoming the eleventh sector in the Global Industry Classification Standard, a change that became official last Friday. The logic behind that belief is that many active managers are under-allocated to real estate stocks and will be forced to buy those names to move inline with their benchmarks with real estate now being its own sector.

That transition became official last week. When S&P Dow Jones Indices and MSCI announced they would create an independent real estate sector, J.P. Morgan projected that active equity funds were so underweight toward REITs that the new sector could cause $100 billion flows to the category. Since the newly minted sector would rival in size to utilities, telecoms and materials sectors, a number of fund managers who have not included REITs exposure may eventually bulk up on real estate.

“Why has performance faded in recent weeks? This change seems to be tied to talk about potential Federal Reserve (Fed) rate hikes. Higher-yielding segments of the market, REITs included, have had a rough past week or so. The recent weakness also may have been caused by the realization that fundamentals have been softening over the past year,” according to a Wells Fargo note posted by Amey Stone of Barron’s.

SEE MORE: 44 Best REITs ETFs to Generate Yields

Wwith the diminished desire for renters to turn into new homeowners, the residential REITs sector could continue to find support from renters as many face rising rents that could keep them from becoming buyers, especially if wages remain stagnant.

“Real-estate gains have been slowing, lending standards have tightened, and real estate insiders have become concerned with fundamentals. With Public Real Estate still up nicely year to date, and autumn approaching (typically a volatile time of the year for the class), we favor taking some profits off the table and reallocating to asset classes we believe have better risk/return tradeoffs,” according to Wells Fargo.

For more information on real estate investment trusts, visit our REITs category.

Vanguard REIT ETF

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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