Sellers of exchange-traded funds that focus on commercial real estate should thank the U.S. Federal Reserve.
The Fed’s policy of keeping the federal funds rate near zero since 2008 while signaling that it won’t climb quickly has helped attract investors to real estate investment trust ETFs, because their payouts are better than investors can get from fixed income.
“We live in a world where investors are thirsty for yield, and since REITs are required to dividend out most of their profits, they’re a good yield vehicle,” said Jim Sullivan, managing director at Green Street Advisors Inc., a Newport Beach, California-based REIT research company.
Almost 35 percent of the money going into U.S. sector-focused ETFs, or $5.6 billion through June 3, was for real estate, according to data compiled by Bloomberg. That makes real estate-focused ETFs the second-most popular category after energy, with $5.9 billion. Vanguard Group Inc.’s REIT ETF had the biggest deposits in the group, with $2.8 billion this year, making it the sixth-most popular U.S. ETF, Bloomberg data show. The Vanguard fund’s shares outstanding reached a record high on June 3.
U.S. commercial real estate is benefitting from high occupancies and rising rents for most property types. The average effective rent, the amount after any landlord concessions, for U.S. office space in the first quarter was $23.66 a square foot, compared with $23.14 a year earlier, according to data from Reis Inc. The vacancy rate declined to 16.8 percent from 17 percent a year earlier.
There’s also limited new supply, which means the market will stay strong, said Brad Case, senior vice president of research and industry information for the National Association of Real Estate Investment Trusts. Construction of office space totaled 6.3 million square feet (585,000 square meters) in the first quarter, compared with 60 million square feet in 2007 before the real estate crisis. Construction for retail space was 650,000 square feet in the first quarter, compared with 1.26 million a year earlier, Reis said.
“Excess new construction is what always ended the commercial real estate party in the past,” Green Street’s Sullivan said. “New supply just isn’t an issue now.”
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.
“In 2014, people have been coming around to the view that rates may stay low for a while,” said Dennis Hudachek, an analyst with San Francisco-based ETF.com. The dividend yield on REITs is attractive compared with the low yields available on fixed-income investments, he said.
A Bloomberg capitalization-weighted index of REITs with market values of at least $15 million had a dividend yield of 3.55 percent. The benchmark 10-year Treasury note yield was 2.6 percent yesterday.
REITs suffered in 2013 after former Federal Reserve Chairman Ben S. Bernanke spoke last May about the central bank scaling back its bond-buying program, sending interest rates higher. The Bloomberg REIT Index fell more than 12 percent last year following Bernanke’s comments. Fed officials are watching the labor market now as they move to complete their bond-purchase program later this year and start considering timing of the first interest-rate increase since 2006.
Investors concerned about a stock-market decline may also be drawn to REIT ETFs since there tends to be low correlation between broad stock-market performance and REIT performance, said NAREIT’s Case. The Standard & Poor’s 500 Index has gained 5.2 percent this year, with dividends reinvested.
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.