Years of low interest rates in the U.S. prompted income investors to look for sources of yield and income beyond U.S. government bonds, but many investors don’t like taking on added risk. This is one factor that has boosted the popularity of real estate investment trusts (REITs) and the corresponding exchange-traded funds (ETFs), including the iShares US Real Estate ETF (NYSEARCA:IYR).
IYR, which debuted 17 years ago, is one of the largest real estate ETFs on the market, boasting more than $4.5 billion in assets under management at the moment.
IYR embodies what investors love about REITs: yield. The ETF carries a trailing 12-month dividend yield of around 4% — well above what the S&P 500 yields, and well above what’s on offer from 10-year Treasuries.
IYR and Its Risks
As is the case with many income-generating assets, such as utilities stocks and junk bonds, REITs are sensitive to changes in interest rates. At least, that’s the market’s perception of real estate investment trusts, with the conventional wisdom being that REITs and funds like IYR are vulnerable to price retrenchment when Treasury yields rise.
Historical data suggests otherwise: Fed tightening cycles don’t hurt REITs.
“During the 1994-1995 tightening cycle, when rate hikes were significant and frequent within a short period, the Dow Jones U.S. Select REIT Index posted negative returns (-5.81%). However, the index had positive cumulative returns (2.64% and 63.66%) during the other two tightening cycles, during which rate increases were fairly steady over time,” S&P Dow Jones Indices says.
Still, IYR sports a three-year standard deviation of almost 14%, which is well above the comparable metric on the S&P 500 and underscore IYR’s sensitivity to rising rates.
Interestingly, the biggest challenge currently facing REITs may not be rising interest rates, but the erosion of brick-and-mortar retailers. Traditional retailers are shutting stores and some are going out of business at a rate not seen since the global financial crisis. That is prompting some short sellers to move on from punishing retail stocks to shorting retail REITs.
IYR allocates more than 14% of its weight to retail REITs. Only specialized REITs — a broad category that makes up 30.7% of holdings — account for a larger percentage of IYR’s lineup.
IYR is one of the most-heavily traded REIT ETFs, so spreads and transaction costs are typically low. However, at 0.44% — or $44 annually on a $10,000 investment — there are less expensive options out there.
As of this writing, Todd Shriber did not hold a position in any of the aforementioned securities.