Are REITs the Holy Grail of Yield?

By Russ Koesterich, CFA iSharesblog.com

 

With interest rates now expected to be low through 2014, investors’ quest for yield is set to continue for years.

As investors relentlessly search for income, I continue to get questions about the role of REITs in a portfolio. While I believe that REITs are a reasonable alternative for investors looking for extra yield, I’m sticking with my neutral view of the sector for a few reasons.

First, a broad index of US REITs is currently trading in line with its historic value versus both the broader market and the US Financial Sector.

Second, and probably more important for yield-hungry investors, the current spread between the yield on a broad REIT portfolio and the yield on the US 10-year Treasury suggests that while REITS are reasonably priced, they aren’t particularly cheap. In fact, the incremental yield over the 10-year Treasury that REIT investors are generating for taking incremental risk is close to the long-term average.

Today, investors are getting around 3% on a broad REIT portfolio, versus the roughly 2% they are getting for the US 10-year Treasury note. In other words, the spread between the yields is roughly 80 basis points, in line with the spread’s 10-year average. (Historically, partly because of the additional compensation investors demand to hold a riskier asset, REITS have typically yielded roughly 80 basis points more than the 10-year Treasury note.)

Finally, though the US housing market is showing signs of stabilizing, I don’t believe this means that investors should aggressively buy REITS. Why? Though the housing market is stabilizing, it’s happening slowly, and the recovery is likely to be a long process. After the bursting of a credit bubble, housing markets typically take up to a decade to come back.

In short, while I don’t think investors need to worry about products that have REIT exposure embedded in them, I would maintain a benchmark exposure to the sector rather than an overweight one.

 

About Russ Koesterich, CFA

Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist as well as the Global Head of Investment Strategy for BlackRock Scientific Active Equities.

Russ initially joined the firm (originally Barclays Global Investors) in 2005 as a Senior Portfolio Manager in the US Market Neutral Group. Prior to joining BGI, Russ managed several research groups focused on quantitative and top down strategy. Russ began his career at Instinet in New York, where he occupied several positions in research, including Director of Investment Strategy for both US and European research. In addition, Russ served as Chief North American Strategist for State Street Bank in Boston.

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