More Upside Seen for a Popular Real Estate Investment Trust

By Todd Shriber, ETF Trends

Last year started with scores of market observers and pundits calling for interest rates to rise. That thesis was, of course, proven wrong and as Treasury yields tumbled, an array of rate-sensitive asset classes soared.

That included real estate investment trusts (REITs) and exchange traded funds such as the Vanguard REIT ETF (VNQ). The new year has started in similar fashion. Ten-year yields slid 23.5% last month, helping launch rate-sensitive bond funds, such as the iShares 20+ Year Treasury Bond ETF (TLT) and the PIMCO 25+ Year Zero Coupon US Treasury (ZROZ) to double-digit gains.

All of that is good news for VNQ, the largest REIT ETF, and rival funds. It is also enough to make VNQ S&P Capital IQ’s focus ETF for February.

“REITs performed well in 2014 and in early 2015 as investors sought out alternative income opportunities with the yield on the 10-year Treasury falling below 2.0%. However, we think REITs can still perform well even if yields climb higher in 2015, depending upon the confirmation and timing of potential rate hikes by the Federal Reserve. We believe the industry is economically sensitive and many of its constituents will be aided by a still-improving U.S. economy. REITs have little to no exposure to weaker geographies in Europe and Asia,” said S&P Capital IQ in a new research note.

After surging 30.4% last year, VNQ is up 5% to start 2015. REITs provide a liquid alternative to owning physical commercial real estate properties. REITs investments also share similar attributes with stocks and bonds. Since REITs are required to distribute at least 90% of their income from rent payments to investors, these real estate investments can generate attractive yields.

Some may be concerned that REITs are sensitive to changes in interest rates. Notably, the fall in interest rates have made the asset more attractive as a yield-generating alternative, but some fear the asset will fall out of favor once rates rise.

“S&P Capital IQ has a positive fundamental outlook on the retail REITs sub-industry. Although challenges remain, we think increasing absorption of retail space should present retail landlords with more pricing power. We expect consumer spending and retail sales to improve over the next 12 months, which should prompt a further slowdown in store closings. We still look for same-property revenue and net operating income to be positive across the sub-industry over the next 12 months. Most retail REITs have long-term leases with their customers that possess embedded rent adjustments that should help insulate them from economic fluctuations,” said the research firm.

After pulling in over $4.7 billion in new assets last year, enough to place it among the top 10 asset-gathering ETFs, VNQ has already added nearly $500 million in new assets in 2015.

“VNQ trades approximately 5 million shares on a daily basis and has a tight $0.01 bid/ask spread. We also believe the ETF is trading with bullish technical trends. Investor interest has been strong with more than $5 billion of fresh money moving into the ETF in the last 12 month,” said S&P Capital IQ.

The research firm rates VNQ overweight, S&P’s highest ETF rating.

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Vanguard REIT ETF (VNQ) is a component of the D2 Capital Management Multi-Asset Income Portfolio. Current yield on the portfolio is 5.57% and year to date the portfolio is down 0.35%, compared to the S&P 500 which is down 2.96% (as of 2 February 2015).

Disclosure:  I own the D2 Capital Management Multi-Asset Income Portfolio

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.