Real estate ETFs riding post-pandemic wave of interest

Even as many parts of the world remain in the throes of the relentless pandemic, exchange-traded fund investors are headed back to the office … and more.

"The reopening trade has lifted all real estate investments trusts, regardless of the interest rate outlook," said Gargi Chaudhuri, head of iShares investment strategy, Americas, at BlackRock Inc. Accessed through ETFs, REITs offer higher yields in a low-interest-rate environment, low correlation to other asset classes, liquidity in a less-liquid asset class, and a natural inflation hedge, Ms. Chaudhuri said.

BlackRock's analysis shows that REITs are 30% to 45% more sensitive to inflation relative to the broad equity market, Ms. Chaudhuri said. "In other words, if we get that rise in inflation expectations, REITs would rise in value by a factor of 1.3 to 1.45."

Current yields for the 52 real estate ETFs tracked by CFRA Research range from roughly 2% to 6%, but activity has been picking up across the board.

"Flows to real estate ETFs are standing out relative to traditional defensive sectors," said Todd Rosenbluth, head of ETF and mutual fund research at CFRA. "And the flows have been relatively broad-based, with several products gathering over $100 million this year. It's not just VNQ — the Vanguard Real Estate ETF," he said.

Of the nine REIT ETFs adding more than $100 million in net assets so far this year, the Invesco KBW Premium Yield Equity REIT ETF added 33% of its $340 million in total assets and the J.P. Morgan BetaBuilders MSCI US REIT ETF added 20.5% of its $1.4 billion in total assets.

Still, VNQ eclipses its competitors like few other ETF strategies.

With $38 billion in assets (and the largest share class of a $68 billion fund), the ETF has a 0.12% expense ratio and holds 174 U.S.-listed real estate investment trusts. However, the next largest product by assets, the $6.5 billion iShares U.S. Real Estate ETF (IYR), with an expense ratio of 0.42%, has greater daily secondary market liquidity.

In aggregate, U.S.-listed real estate ETFs had $80.4 billion in assets under management through May 3, according to CFRA. Net inflows were $3.9 billion compared to a net outflow of $2.2 billion for 2020. One notable exception in 2020 was the $1.1 billion Pacer Benchmark Data & Infrastructure Real Estate SCTR ETF, which gathered $831 million last year alone as the pandemic highlighted the importance of data centers and communications towers to a socially distanced world.

REIT ETFs have had a median total return of 15.1% in 2021 through May 3, compared to a median decline of 7.3% for 2020.

For pensions, endowments and other long-term holders, the publicly traded market for real estate — easily accessed through ETFs — offers an opportunity to shift or reweight a traditional portfolio to emerging areas of growth. In its December 31 regulatory filing, for example, the Canada Pension Plan Investment Board disclosed a new 2.25 million share position in IYR, while the State of New Jersey Common Pension Fund D and the State of Tennessee, Treasury Department, are holders of VNQ.

The state of Tennessee utilizes VNQ in its OPEB trust fund and the Tennessee Promise Scholarship Trust Fund, which both hold portfolios of ETFs. "Purchasing VNQ allows us to obtain efficient exposure to the REIT sector and to the real estate portfolios that underlay the REITs," Chief Investment Officer Michael Brakebill said in an email.

Yet according to Green Street data through 2018, pension fund real estate allocations in aggregate allocated roughly 5% to private real estate and less than 1% to public REITs. In Green Street's analysis of institutional ownership of public REITs, 41% is held by passive strategies, 55% by active strategies, and 4% by pensions directly.

"The REIT industry has undergone a dramatic transformation," according to a March research note from Green Street. "Traditional sectors (apartment, office, retail, industrial) now account for just 40% of the equity REIT universe. Property types previously considered to be tiny niches or once simply unfathomable in the REIT structure have blossomed. Today's REIT universe reflects tomorrow's economy far better than does the traditional definition of real estate."

Take, for example, the recently launched Invesco MSCI Green Building ETF. More global in nature, with only 27% exposure to the United States, the new ETF is looking to capitalize on investor-preferences for more environmentally aware products by holding a portfolio of real estate investment trusts or companies that have made a strategic commitment to green building and derive more than 50% of their revenue from the green building theme. The fund carries a 0.39% expense ratio.

"Green building projects take 11% more time to build and cost 6% more, but they can earn premium rents of 13% to 37% more," said Rene Reyna, head of thematic and specialty product strategy, ETF and indexed strategies at Invesco U.S.