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As you can see below, the Vanguard REIT ETF fund hasn't been doing very well for the last 6 months, but the housing market seems to be improving every month. Why do we have this difference?

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VNQ only holds ~16% residential REITs. The rest are industrial, office, retail (e.g. shopping malls), specialized (hotels perhaps?) etc.

Thus, VNQ isn't as correlated towards housing as you might have assumed just based on it being about "real estate."

Second of all, if by "housing" you mean that actual houses have gone up appreciably, then you ought to realize that residential REITs seldom hold actual houses. The residential units held tend primarily to be rental apartments. There is a relationship in prices, but not direct.

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    Great remarks. I really got this wrong. So I guess the next question will be, which ETF should I research that correlate with the housing market? – Geo Jan 15 '14 at 18:19
  • VMBS may be a better ETF in that it deals with mortgage-backed securities from GNMA, FNMA and FHLMC. – JB King Jan 15 '14 at 18:35
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    @Geo why don't you ask it as a separate question? But note that this must be regional, since there are many markets even in a single country (especially as large as the US) – littleadv Jan 15 '14 at 18:35
  • @Geo A separate follow-up question is a good idea. You can link to this one. – Chris W. Rea Jan 15 '14 at 20:20
  • @JBKing While there'd be a relationship between the health of housing & mortgages, the VMBS ETF (or any similar) isn't a good proxy for an investor to participate in real estate prices. Mortgage-backed securities are debt, like bonds, and they'll react more to changes in interest rates, credit risk, etc. Think: The holder of a mortgage doesn't participate in the upside; i.e. your bank doesn't get wealthier from your mortgage if your house value triples -- they are still just due back the principal loaned, plus interest. Higher home equity might make your mortgage less a credit risk, though. – Chris W. Rea Jan 15 '14 at 20:29
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To round out something that @Chris W. Rea pointed out, the business that a REIT is in will be either A) Equity REIT... property management, B) mortgage REIT... lending, or C) hybrid REIT (both).

A very key point about why REITs broadly have been struggling lately, (and this would show up in the REIT indices/ETFs you've linked to,) is linked to the REIT business models.

For an Equity REIT, they borrow money at the going rate (let's say ~4.5% for commercial-scale loans), and use that to take out mortgages on physical properties. If a property rents for $15K per month, and they can take out a $1.8 million loan at $9,000 per month, then their business is around managing maintenance, operating expenses, and taxes on that $6,000 per month margin.

For a mortgage REIT, they borrow funds as a highly qualified borrower, (again let's say ~4.5%), and lend those funds back out at a higher rate. The basic concept is that if you borrow $10 million at 4.5% for 30 years, you need to pay it back at $50,668 per month. If you can lend it out reliably at 5%, you collect $53,682 per month... a handy $3,000 per month. The cheaper you can get money at (below 4.5%) and the higher you can lend it at (above 5%), the better your margin is.

The worry is that both REIT business models are very highly dependent on the cost of borrowing money. With the US Fed changing its bond-buying/QE/stimulus activity, the prevailing interest rates are likely to go up. While this has its benefits (inflation), it also will make it more expensive for these types of companies to do business.

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