2023 is one year real estate investors would like to forget. Overall, the sector underperformed as rising interest rates crimped enthusiasm for real estate investment trusts (REITs). At the same time, those higher rates did double damage to would-be buyers of properties. The resulting perfect storm was a recipe for underperformance and losses across the sector.
But the new year could be different.
Thanks to several bullish tailwinds, low asset prices, and a thawing on the Fed’s interest rate tightening, REITs could be a standout in 2024. And ETFs covering the sector could be a major buy for investors.
A Mixture of Dread
REITs have been a wonderful asset class for income seekers and those looking for a strong total return. But every once in a while, the sector goes through a series of big hiccups. Last year was one of those years.
The blame could be squarely placed upon the Federal Reserve. It’s no secret that the Fed has continued to ratchet up interest rates over the last year, pushing benchmark rates to 5.5%. For REITs and the broader commercial real estate sector, this has created a one-two punch of sorrow.
For starters, REITs are required to push out 90% of their cash flows back to investors as dividends. As such, they generally have very high yields. Well, with cash and ultra-safe Treasury bonds now yielding 4.5% to 5.5%, investors did not have to take on risk to get yield. So, REITs were sold in favor of safety. Over $10.3 billion fled real estate mutual funds and ETFs in 2023. This followed more than $18 billion worth of outflows in 2022.
At the same time, rising interest rates made it harder to get real estate deals done and rendered them more expensive due to rising mortgage costs. Property values in many areas suffered. This hit book values and put REITs in a precarious position.
All in all, total returns on the FTSE NAREIT All Equity index were a negative 24.95% in 2022. REITs spent much of 2023 in the red as well, only finishing the year in positive territory after a late fourth quarter surge. However, returns for the sector still managed to trail the S&P 500 by nearly 15 full percentage points.
In a nutshell, real estate hasn’t been the best place for investors during the current environment.
Bullish in the New Year
But investors may not want to give up on REITs just yet. In fact, they may want to buy them with both hands. Several headwinds have started to blow in the opposite direction.
For one thing, rates are predicted to start dropping in 2024. Thanks to the dwindling economic and inflation data, the Fed has already suggested that they will cut rates by roughly 0.75% this year. That’s huge for REITs, both for share prices and their expenses. Investors will once again turn to ‘risk’ to get yield, while borrowing costs will decrease, boosting cash flows.
Aside from rates, there are a few other factors that could help generate strong REIT returns.
One is a lack of supply. As we said, rising rates made it hard to get mortgages. This includes construction loans. A variety of industries—industrial, digital, apartment, and even select retail spaces—are predicted to see demand outstrip supply. That will drive rent growth and profits for the sector.
Then there are valuations themselves to consider. After the multi-year rout, REITs are cheap. Since 2022, multiples for the asset class have declined by 35%, making them very cheap. However, at the same time, earnings have actually gone up on average by 15%. So, they are making more money and now they are much cheaper.
Taking the REIT Approach
Given this, analysts now expect REIT returns to surge in 2024. For example, real estate-focused investment manager Cohen & Steers predicts that REITs could deliver returns in the 10% to 13% range, above their historic average. However, some managers believe that REITs could pull in gains as much as 25% given just how beaten down they are.
Either way, adding REITs makes a ton of sense. One of the best ways to do so could be through ETFs. Thanks to their broad nature, ETFs allow investors to tackle a variety of property types all at once. This diversification factor allows for smoother returns and potentially more income. Moreover, ETFs are a low-cost and liquid way to play real estate. Just ask any investor looking to sell out of their private REIT how important liquidity is.
So where to start?
Yield might be a good place. High-yielding REITs will certainly get the nod from investors as the Fed starts cutting. The Hoya Capital High Dividend Yield ETF targets this income side of real estate by focusing on common and preferred stocks issued by REITs. This creates a high-yielding picture. The Invesco KBW Premium Yield Equity REIT ETF follows a similar high-yielding approach. Both yield over 8%.
Another choice could be to focus on subsectors of the market that have plenty of fundamental wins. This includes housing, digital, and industrial properties. The Pacer Industrial Real Estate ETF, iShares Residential and Multisector Real Estate ETF, and Hoya Capital Housing ETF are some examples. The Hoya fund could be particularly interesting given that it plays the entire housing ecosystem and includes those firms that will benefit from lower mortgage costs such as home builders as well.
REIT ETFs
These funds were selected based on their exposure to the real estate sector. They are sorted by their one-year total return, which ranges from -1.8% to 22.5%. They have assets under management between $40M to $65B and expenses between 0.10% and 0.50%. They are yielding between 2% and 9.5%.
| Ticker | Name | AUM | 1-Year Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| HOMZ | Hoya Capital Housing ETF | $40.16M | 22.5% | 2% | 0.30% | ETF | No |
| REZ | iShares Residential and Multisector Real Estate ETF | $657.73M | 4.6% | 4% | 0.48% | ETF | No |
| XLRE | The Real Estate Select Sector SPDR Fund | $5.73B | 3.5% | 4.3% | 0.10% | ETF | No |
| IYR | iShares U.S. Real Estate ETF | $4.52B | 3.3% | 3.4% | 0.40% | ETF | No |
| VNQ | Vanguard Real Estate Index Fund | $64.86B | 3% | 4.9% | 0.12% | ETF | No |
| ICF | iShares Cohen & Steers REIT ETF | $2.15B | 2.7% | 3.8% | 0.33% | ETF | No |
| RIET | Hoya Capital High Dividend Yield ETF | $55.36M | 2% | 9.5% | 0.50% | ETF | No |
| KBWY | Invesco KBW Premium Yield Equity REIT ETF | $238.76M | -1.8% | 8.2% | 0.35% | ETF | No |
Whether investors go for yield, get specialized or simply choose a broad REIT fund, the sector is ripe for strong returns in the new year. Ultimately, many of the headwinds are starting to change. For investors, that is a huge win and reason to buy the beaten down sector.
The Bottom Line
After two years of poor returns, REITs could be ready to win. And that makes REIT ETFs a top portfolio play. Thanks to their low costs and high yields, REIT ETFs have the ability to make the most out of the changing environment and capture the sector’s potential.