QE3 isn’t doing income investors any favors, and that could be a boon to some real estate investment trusts (REITs).
Sure, the Federal Reserve’s third round of quantitative easing should give all sorts of risk-assets a lift, from energy and food futures to the broader stock market. But by targeting the mortgage-backed securities market — with open-ended purchases of $40 billion a month — equity REITs could deliver even better returns.
Fitch Ratings, the No. 3 credit rating agency after Moody’s (NYSE:MCO) and Standard & Poor’s (NYSE:MHP), said that if QE3 works as intended, equity REITs would likely benefit approximately 12 to 24 months down the road.
“We believe ownership and long-term financing of commercial assets ties equity REIT performance closely to the general economy,” Fitch writes. “If the plan maintains or causes a decline in long-term U.S. Treasury rates, we would expect a drop in all-in borrowing costs for REITs.”
Lower rates wouldn’t just make borrowing costs drop for REITs, but would also make income for investors even harder to scare up. Squeezing investors out of bonds and into stocks is a big-part of what QE is supposed to do. At any rate, lower rates could spur more investors to allocate money to REITS, Fitch notes, in no small part because REITs’ stable dividends will compare even more favorably to other income (or rather, lack thereof) investments.
REITs offer not only the chance of price appreciation, but they’re required to return most of their cash to shareholders, making for some enticing payouts. Just as equity-income investors have been gorging on dividend stocks in their hunger for yield, REITs have also found themselves featured prominently on the menu.
Equity REITs invest in and own their own properties, with the rents providing the bulk of revenues. That’s the class of REIT Fitch sees as benefiting the most from QE3 — if it works.
The easiest and safest way for investors to gain cheap, diversified exposure to equity REITs is through the Vanguard REIT Index ETF (NYSE:VNQ). With an expense ratio of 0.1%, VNQ is unbeatable on fees. The category average is 0.43%, according to data from fund-tracker Morningstar.
It’s also the largest REIT ETF, with more than with $15 billion in assets, and it has yielded a healthy 3.24% over the trailing 12 months.
Meanwhile, VNQ has generated a total return (that is, price gains plus dividends) of more than 20% for the year-to-date, beating the S&P 500’s total return by 2 percentage points.
Of course, if you’re looking to take on more risk, you could go cherry-picking among individual names. As InvestorPlace contributor Chris Johnson notes, “QE3 will focus the ‘Bernanke Put’ on the housing market and related stocks.”
That leaves some high-yielding REITs set to outperform, according to Johnson Research Group, including Duke Realty (NYSE:DRE), which currently yields 4.3%, and Plum Creek Timber Holdings (NYSE:PCL), which currently yields 3.8%.
Still, for safety’s sake, you’re probably better off going with the Vanguard’s VNQ ETF, where diversification will stand you in good stead.
All in all, QE3 might continue to give REITs a lift because of the paucity of competing income-generating assets out there. But the part where REITs do well because QE3 spurs on the recovery? That’s very much in doubt.
As of this writing, Dan Burrows did not own a position in any of the aforementioned securities.
