Real Estate Stocks & Funds

Dr K C Gupta, YBB Personal Finance

REAL ESTATE (RE) stocks & funds are highly rate-sensitive & may be considered bond proxies although they are more volatile. In RE, much of the depreciation is available for distribution, so RE has its own unique evaluation tools such as funds from operations (FFOs), AFFO (adjusted FFO), capitalization rate (cap-rate), etc; the P/E ratios used for equities are not useful.

Real estate investment trusts (REITs) represent the largest portion of the RE stocks & funds. They have tax preferences but are required to distribute 90% of their income & have other requirements. They rely on capital markets for funds needed for growth, so they are tied to business & market cycles. They are quite diverse. The attractive REIT sectors include apartments/ multifamily-housing (AVB, EQR), data-centers (EQIX, DLR), wireless towers (AMT, CCI), self-storages (PSA, EXR), industrial (PLD, REXR) & healthcare (WELL, VTR, MPW).

The REIT sectors under pressure are big malls (O, FRT), offices (ARE, BXP) & REITs holding CREs; changes in consumer shopping habits & hybrid home-&-office work patterns have caused disruptions in these areas. Some are being repurposed, but that is quite expensive. A related problem is that the CREs on the balance sheets of many regional banks are underwater, but this problem can remain hidden for years until the banks have to sell those to raise large amounts of cash quickly.

RE has been included in the GICS 11 sectors (S&P, MSCI) since 2016. The RE categories include REITs, RE operating companies (REOC – BAM, ARL), RE development companies (JOE), RE services companies (CBRE, JLL, CWK); however, the mortgage mREITs are excluded as those remain under the financial sector. In 2016, the old financial ETF XLF was split into the new financial ETF XLF & RE equity ETF XLRE. 

Examples of RE EQUITY mutual funds (OEFs) include VGSLX, FRESX, CSJAX/ CSRSX, TCREX/ TRRSX/ TIREX; the ETFs include VNQ, XLRE, SCHH, IYR; the closed-end funds (CEFs) include RFI, RQI, IGR, JRS, NRO. Most funds broadened their mandate from REITs to RE equity after 2016.

The RE HYBRID funds include RE equity, fixed-income & convertibles; they have lesser volatility than RE equity funds. There are only a few such funds (FRIFX).

DIRECT RE is all/majority-owned & professionally managed RE but most funds are variable-annuities (VAs) or private funds. An example of the former is the TIAA Real Estate Account VA (QREARX) that has Liquidity-Guarantee of once-per-quarter withdrawal per account (but amounts aren’t restricted). In other such funds, there may be redemption restrictions, fees or gates.

Private or NONTRADED REITs/REs are illiquid & their redemption restrictions are described in their prospectuses – typically monthly (1-2%) & quarterly (5%) withdrawal limits as percentage of fund assets. So, they are easier to get in through advisors or brokers but are tougher to get out as there is no secondary market. The biggest nontraded RE is Blackstone BReit; there is also a smaller Starwood SReit. SEC & FINRA have issued investor alerts for nontraded REs as there have been consumer complaints that they were not adequately informed about their rules & restrictions (that are in long prospectuses).

An indirect RE play is “homebuilders” ETFs ITB, XHB, PKB. These include homebuilding companies (DFH, LEN, PHM, TOL) & home-improvement product manufacturers & suppliers (HD, LOW, CARR, SHW). These react fast to interest rates, housing starts, home prices & home sales.

Leveraged mortgage mREITs (NLY, AGNC, STWD, BXMT, TWO) are still part of the financial sector (XLF). These highly leveraged MBS (bond) portfolios are very interest rate sensitive. mREITs ETFs include REM, MORT.

There are foreign & global RE funds. But RE in many countries may be more speculative & there may be PFIC tax issues for the US investors. The PFIC rules arise because there are many restrictions on funds in the US, but those restrictions may be different or lax in other countries. Among other things to level the playing field, the PFIC rules flow portfolio gains/losses through funds’ income statements & that may cause their income & dividends to be uneven or lumpy for the US investors; occasionally, the dividends may be skipped just because of these rules, but general situation with the fund may be normal.

The focus here has been on RE stocks & funds. But owning RE & renting may also suit many. It has advantages & disadvantages & may not be easily scalable.

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