In their zeal for yield, investors have been loading up on U.S. real estate investment trusts to the point where this asset class has perhaps become too popular: A basket of publicly traded REITs as measured by the SPDR Dow Jones REIT ETF (RWR), which tracks the 83 components of the Dow Jones U.S. Select REIT Index, has risen about 250% since bottoming out in early 2009. That rise has pushed a once-respectable yield down to just 2.9%.
Investors looking for higher yields and better values in this asset class should look overseas. “They tend to be a little cheaper in terms of price-to-sales and price-to-earnings than their U.S. peers,” says Jeremy Schwartz, WisdomTree’s research director.
Equally important, real-estate focused ETFs outside the U.S. sport higher relative payouts then their U.S.-focused counterparts––whereas the SPDR Dow Jones REIT ETF yields less than 3%, several globally-focused ETFs sport yields exceeding 5%.
Why the disparity? “They’ve proven to be quite volatile so investors have demanded the higher yields to compensate for that risk,” says Todd Rosenbluth, ETF research director at S&P Capital IQ.
But Schwartz doesn’t buy into that argument about risk. “The non-U.S. REITS carry roughly one-third less debt leverage, which to my mind lowers risk,” he says. He concedes that currency effects in places such as Australia and Hong Kong can impede dollar-adjusted performance.
It’s important to keep in mind that that income-focused asset classes such as real estate could be negatively impacted by rising global interest rates, both in terms of higher financing costs for the developers and in the relatively greater appeal that other asset classes may hold in a rising rate environment. Still, rates are expected to remain quite low for at least a few more years.
Once Size Doesn’t Fit All
Of course, when talking about global real estate, you need to make some clear regional distinctions. European real estate remains in a deep slump, though a lack of new construction activity means that supply has been constrained, setting the stage for rising rents and selling prices as the Eurozone recovers.
Schwartz suggests investors focus on emerging markets, where vigorous economic activity has led to a surge in construction activity and asset prices. “Europe still has a lot of risk and I think the Asian growth stories are much more attractive,” he says.
Here’s a quick survey of globe-spanning real estate ETFs:
SPDR Dow Jones International Real Estate (RWX)
With $3.7 billion in real estate assets, this is the granddaddy of the category, and its focus on Canada, Europe and Asia helps bring diversification. In an unusual twist, more than one-third of the fund’s assets are tied up in real estate developers, and not just the REITs that most ETFs focus upon. That provides a slightly greater emphasis on growth, and not just income, though the current 6.4% yield is meaty. That said, the greater portfolio complexity may help explain why this ETF sports a 0.59% expense ratio, the highest in the category.
iShares FTSE EPRA/NAREIT Developed Real Estate ex-US (IFGL)
As noted earlier, Asian real estate is in the midst of a multi-year boom, and even the moribund Japanese real estate market has rumbled to life after a long period of dormancy. Roughly two-thirds of this fund’s assets are tied up in Asia, with a considerable chunk dedicated to Japan. That has helped boost the IFGL roughly 30% since the start of 2012. Still, shares are more than 20% below where they stood five years ago, and have only partially recovered from the 50% plunge in 2008.
The 0.48% expense ratio is among the lower half of the sector, while the 5.5% distribution yield is near the top of the peer group. “That yield is pretty compelling,” says S&P’s Rosenbluth, “especially when you consider it is among the least volatile––and risky––of the group with a beta of just 1.1.”
Vanguard Global ex-US Real Estate ETF (VNQI)
Investors in search of a lower-cost path to global exposure may want to check out this ETF, which carries a 0.35% expense ratio, the lowest in the category. The VNQI was launched in late 2010, avoiding much of the carnage that took place a few years earlier.
This Vanguard fund, which generates a 5.5% distribution yield, owns a combination of REITs and real estate developers in 35 countries, greatly reducing country and region-specific risk. Still, with 25% of the portfolio tied up in Hong Kong and Singapore-based property developers, this fund has substantial indirect exposure to mainland China. For example, this fund underperformed the peer group in 2011 as fears of a slowdown in China grew, but rallied a solid 40% in 2012 as those fears receded.
Guggenheim China Real Estate ETF (TAO)
This fund might give some investors pause because the Chinese real estate sector shows many signs of overheating. A recent piece on 60 Minutes highlighted a number of cities with vast tracts of newly-built empty residential skyscrapers. Corporate office space isn’t nearly as overbuilt, according to various media reports, but this ETF has exposure to all types of real estate. Shares of this ETF have already slipped more than 10% since the year began, and its 1.7% yield isn’t especially impressive.
Still, with the Chinese economy eventually poised to become the world’s largest, this ETF is worth tracking for an eventual solid entry point. And despite a series of bumps along the way, the fund has managed to handily outperform the MSCI EAFE global investing index on a one-, three- and five-year basis. Yet volatility is the theme here: This fund has fallen at least 25% in two of the past five years, and risen at least 50% in two other years in that time frame.
Though global real estate prices have rebounded from the recession-era lows, they still have ample upside ahead as Asian economies continue to strengthen while major European economies start to shed their austerity-induced restraints. The construction lull in Europe may actually set the stage for a dynamic supply-and-demand trend that fuels above-average pricing and occupancy trends. These globally-focused ETFs look like a way to play this sector as the real estate market thaws.