“People have been worried that this sector was going to run out of steam as the housing market got back on its feet,” he says, “but that’s not taking into account the huge pent-up demand for all types of housing. There is still a lot of excess demand for apartments even though construction has been fairly strong. And the strong jobs market is keeping that sector really tight. That’s good for the property owners because that allows them to raise rents.”
Interest Rate Play
Investors looking to bet on the way interest rates affect the residential mortgage market can invest in mortgage REITs, which earn interest income by originating mortgages and purchasing mortgage-backed securities. Over the past five years, these REITs have had a 9% total annual return and yield about 11.5%, according to Nareit.
“Right now, my firm generally believes taking interest rate risk to get a return is preferable to taking credit risk,” says Patrick McDowell, a fiduciary financial advisor at Arbor Wealth Management in Destin, Fla. “We believe that short-term rates are as likely to go down as up and that long-term rates won’t fall to extremely low levels.”
His pick in this sector is Annaly Capital Management (NLY). “Annaly assumes almost no credit risk, so the main risk they are taking is interest rate risk,” McDowell says. “They essentially are like a bank in that they do better when the spread between short-term and long-term rates widens or stays consistent.”
REIT ETFs
Robert R. Johnson, professor of finance at the Heider College of Business at Creighton University and the former president and CEO of the American College of Financial Services, says the best opportunities for investing in REITs today are in widely diversified REITs, meaning REIT ETFs. These funds “tend to be less volatile than individual REITs, which makes them quite attractive to new investors,” he says.
He recommends the Vanguard Real Estate ETF (VNQ), the SPDR Dow Jones Global Real Estate ETF (RWO) or the Schwab U.S. REIT ETF (SCHH). Each offers broad diversification across several individual REITs, thus the investor should earn close to a market average return for the REIT category.
Martin Kremenstein, head of ETFs at Nuveen, also likes REIT ETFs. He recommends the Nuveen Short-Term REIT ETF (NURE), which concentrates on REITs that have the shortest duration contracts. These include hotels, storage lockers, residential real estate and manufactured housing.
“Having shorter business contracts—from one day up for hotels, multi-month for storage lockers and up to two to three years for manufactured housing—enables these REITs to be nimble in a volatile rate environment and avoid getting locked into long-term contracts when the rate and business environment is changing rapidly,” Kremenstein says.