A Diversified REIT ETF may Proxy Physical Real Estates in an Asset Allocation Model

- Intended for Start-up Analysts and Researchers -

The Correlation Matrix (top graphic) shows the correlation between S&P 500 and five publicly traded Real Estate Investment Trust (REIT) ETFs. While MORT is a mortgage REIT, the other four are diversified equity (Real Estate) REITs. 

The Correlation Matrix shows almost negligible correlations between S&P 500 and the REITs. This lack of correlation entices investors to own REITs as a separate asset class in their asset allocation model, proxying a portfolio of diversified real estates (residential, commercial and industrial), without having to own and manage them physically. 

In order to maintain the tax advantage status, REITs have to pay out at least 90% of their income as dividend. Since REITs are designed to yield higher dividends, they tend to complement the fixed income (asset) class in the asset allocation model as well.

Correlation coefficients ranging between + 0.10 and -0.10 are considered uncorrelated. VNQ is the only one that falls outside of that range, showing slightly negative correlation. Save MORT, the other four equity REITs are moving in lockstep, considering their top holdings (accounting for at least 35% of the portfolio) are virtually alike (e.g., American Tower, Simon Property, Crown Castle, Prologis, Public Storage, Avalon Bay, Equinix, Equity Residential, Digital Realty, etc.).

Though Mortgage REITs tend to generate much higher yields than their equity (real estate) counterparts, they are inherently more volatile as they are more prone to interest rate fluctuations. MORT currently has a yield of 7.77% as compared to 3% to 4% for the equity ones.
     
The weekly graph (bottom graphic) is more telling. While S&P 500 moved from 2,400 to 2,800 (between 8/1/17 and 7/31/18), both REITs (IYR and VNQ) remained range bound between $74 and $82. As a result, the diversified equity REITs have low beta as well (usually between 0.5 and 0.7). 

Again, a diversified equity REIT ETF could be an excellent way to own this asset class (a wide variety of real estates) without having to physically own and manage them.

Disclaimer - The author is not advocating any of the ETFs/indices listed here. Consult your Registered Rep, RIA or Financial Planner for an appropriate asset allocation model and the suitability of stocks and other holdings for your portfolio.

- Sid Som, MBA, MIM

President, Homequant, Inc.

homequant@gmail.com

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