Investment flowing into exchange-traded funds focused on real estate this year has already eclipsed the 2013 total as concern over rising interest rates subsides and property markets improve.
In 2014, 31 percent of money going into U.S. sector-focused exchange-traded funds, or $3 billion through March 6, was for real estate, according to data compiled by Bloomberg. That’s 43 percent more than the net deposits the funds attracted in all of 2013, and a greater share of total ETF contributions than any time since at least 2012.
Investor expectations that interest rates won’t climb dramatically have made commercial property and mortgages attractive as the economy grows. Real estate investment trusts fell last year as the Federal Reserve said it would pare its unprecedented bond buying, which lowered borrowing costs for deals. Landlords are filling office, industrial and retail space amid a lack of new construction, brightening the outlook.
“If you trust the bond market, which we do, we’re in an OK environment for cost of capital,” said Jim Sullivan, managing director at Green Street Advisors Inc., a Newport Beach, California-based REIT research company. “We have enough economic growth to keep buildings full to allow landlords to push rents, not a lot, but a little.”
ETFs are securities that track an index or basket of stocks or bonds in a given market or industry sector. They can be easily traded and come with low costs. Inflows to U.S. ETFs more than tripled to $183 billion last year from 2004, according to data compiled by Bloomberg.
Vanguard Group Inc.’s REIT ETF has led real estate products in attracting money with $1.25 billion in inflows in the past month. In second was BlackRock Inc.’s iShares U.S. real estate ETF, which gained about $506 million, according to Bloomberg data.
The biggest component of both ETFs is Simon Property Group Inc., the largest U.S. mall owner. The Indianapolis-based REIT has climbed 7.5 percent not including dividends this year after a 3.8 percent decline in 2013, its worst performance since 2008. The company in January reported an 8 percent jump in fourth-quarter funds from operations, a REIT measure of cash flow, as occupancies and rents climbed.
Investors put $97.5 million into the iShares Mortgage Real Estate Capped ETF in the past month, making it No. 4, Bloomberg data show. The ETF tracks an index made up of mortgage REITs, such as Annaly Capital Management Inc., its largest holding, which has returned 12.4 percent this year. The fund offers a yield, using calculations by the Securities and Exchange Commission, of 11.2 percent, according to BlackRock’s website.
“Deep discounts coming into the beginning part of this year combined with the dividends these REITs are paying woke people up to the fact that they looked pretty attractive,” said Gavin James, chief executive officer of Western Asset Mortgage Capital Corp., a Pasadena, California-based mortgage REIT.
REITs buy property-linked assets and are exempt from taxes as long as they pay out 90 percent of their taxable income in dividends, making them attractive to investors seeking steady returns. By paying out profits, the companies also are dependent on capital markets to finance acquisitions and development.
The Bloomberg REIT Index, consisting of property owners, reached a six-year high in May and plunged 18 percent including dividends into August on concern that the Fed scaling back its stimulus would push up interest rates. They have since gained 14 percent from that low as that scenario failed to materialize. U.S. mortgage REITs returned 18 percent since Dec. 6, after dropping about 2 percent last year, and are now at their highest since June.
The yield on the 10-year Treasury has dropped to about 2.73 percent after climbing to as high as 3.03 percent at the end of last year. The dividend yield on the Bloomberg REIT index is 3.6 percent. Some parts of the market are yielding even more, such as single-tenant REITs, which have a dividend yield of 5 percent.
“Interest rates went up, but the reaction on REITs was way overdone,” said Rich Moore, an analyst at RBC Capital Markets in Solon, Ohio. “It’s a combination of good yields out there which everybody likes and the fact that interest rate fears have gone down.”
Commercial real estate rents and occupancies are rising as the economy grows. The average effective rent, the amount after any landlord concessions, for office space in the U.S. in the fourth quarter was $23.48 a square foot, compared with $22.98 a square foot a year earlier, according to data from Reis Inc. Retail rents climbed to $16.83 a square foot in the fourth quarter from $16.59 a square foot a year earlier as the vacancy rate declined to 10.4 percent from 10.7 percent.
Moore said a paucity of new construction also is helping landlords.
“New construction is low by historical standards,” said Paul Curbo, a portfolio manager in Dallas with Invesco Ltd., which had $23 billion in real estate securities under management at the end of December.
Self-storage companies and single-tenant REITs are the best performing parts of the property REIT market this year. The self-storage REIT index climbed 13.3 percent this year through March 6, while the single-tenant REIT index gained 13.5 percent.