If you’re pondering the allure of real estate investment trusts (REITs) these days, consider two attributes of late: strong performance vs. the US stock market and relatively high yields over Treasuries. As winning combinations go among asset classes at the moment, US REITs cast an attractive profile.
A couple of charts tell the story, starting with performance. Compared with US equities, REITs are holding their own over the past year (252 trading days). The SPDR S&P 500 ETF (ARCA:SPY) is up more than 14% on a total return basis through yesterday’s close (October 28) over that span, but US REITs–Vanguard REIT ETF (Vanguard (ARCA:VNQ)—have climbed a bit more, boasting a 15.8% gain.
As an added bonus, REIT yields continue to offer a comparatively hefty payout vs. government bonds. Based on VNQ’s yield premium over a U.S. 10-Year Treasury Note, the spread remains competitive at roughly a 1.3 percentage point spread as of Oct. 28. (Note: VNQ’s daily yield is calculated by taking a rolling sum of the trailing four-quarter distributions for computing the current yield relative to the daily closing price.)
In a low interest-rate environment, the relatively rich payout with REITs offers obvious appeal. “Falling rates have been a huge tailwind for REITS,” said FMD Capital Management’s David Fabian last week at ETF.com’s fixed-income conference.
With expectations that today’s FOMC statement will lean on the dovish side–despite the end of quantitative easing–the potential for an extended run of low rates remains a reasonable forecast. If so, REITs will continue to be a popular destination for capital allocations in a yield-starved world. “Markets are banking on the prospect that the Federal Reserve will do everything in its power to anchor interest rate expectations at, or below, current levels,” advised Michael Hewson, chief strategist at CMC Markets.
REIT yields aren’t written in stone, of course, and so there’s no guarantee that the current spread for the asset class is a reliable projection of what you’ll actually earn going forward. Payout rates, along with prices, will continue to fluctuate, as they say. But the fact that the yield spread for REITs has remained in the one-to-two-percentage point range in recent years implies that there’s a decent chance that VNQ and similar products will continue to deliver a healthy payout premium over a 10-year Treasury Note.
The risk, of course, is that the game will change when interest rates start rising. For the moment, however, that’s still considered a low-probability event for the near term, according to the Fed funds futures market. A rate hike in mid-2015 at the earliest is the crowd’s best guess at this point. It seems that there’s still a good case for grabbing some extra yield in REITs… at least until the Fed signals that’s it time to think differently.