There are nearly daily headlines talking about doom in the office sector as hybrid working schedules have decreased demand for offices and left the sector’s overall outlook in doubt. So, it might seem like an odd time to build an ETF focused on the sector. Yet that’s exactly what VanEck has decided to do with the launch last week of the VanEck Office and Commercial REIT ETF (DESK).
VanEck, which has more than 50 ETFs offerings, sees DESK as a tool for an investors looking to express their view on the future of offices in an ETF form. While there are dozens of ETFs built off publicly-traded REITs, DESK is the first to focus solely on the office sector. It’s part of a trend that’s included a number of new real estate ETFs that rather than trying to encompass the entire REIT sector focus on specific themes. Other specialized real estate ETFs include the NETLease Corporate Real Estate ETF (which focuses solely on net lease REITs), the Liquid REITs ETF, (which is meant to ape the performance of non-traded REITs by using public REITs to follow the allocation roadmap of some of the leading non-traded REITs) and the AXS Real Estate Income ETF (which focused on residential and commercial mortgage REITs).
DESK seeks to track the performance, before fees and expenses, of the MarketVector US Listed Office and Commercial REITs Index, which tracks the overall performance of U.S. exchange-listed REITs operating in the office and commercial real estate markets.
WMRE spoke with VanEck Product Manager Coulter Regal about the new ETF.
This interview has been edited for style, length and clarity.
WMRE: The obvious question to start with is, “Why now?” The office sector is facing a reckoning. Why is it the time to have an ETF focused on that segment?
Coulter Regal: Office properties and commercial real estate more broadly have faced a lot of challenges due to the pandemic and the shift to work-from-home. That trend has persisted longer than people initially thought. VanEck views these challenges in the broader context and the longer term trends. For some investors, it might be a contrarian opportunity. It could be a short-term tactical or long-term capital appreciation investment in this area. Prior to DESK, there was not an ETF focused on this segment. It’s an opportunity to be an efficient vehicle focused on offices and a way to express views one way or the other on this particular market.
WMRE: This also seems to me to be part of a trend where the first round of ETFs built off REITs were largely broad market indices and now we’re seeing some ETFs built with narrower themes. Is that accurate?
Coulter Regal: That is exactly right. If you look in terms of AUM, for REIT ETFs, the vast majority are based on the broad REIT market and are relatively diversified. We have seen recently some of these more focused ETFs with targeted exposure. They give investors to tools to dial up or dial down on particular segments. It’s one of the great benefits of ETFs. Investors can move in and out of exposures with a signal trade. We wanted to provide that trading tool to investors to use how they see fit.
WMRE: How did you build the underlying index for this ETF?
Coulter Regal: We worked with MarketVector. One of the challenges in developing a rules-based index for office REITs is that office REITs are a small slice of the REIT market both in terms of the number of publicly-traded REITs and in terms of market caps. So, from a liquidity perspective and an efficient universe perspective, if you look closely, it is focused on office REITs with an 80% exposure, but because of the smaller size of the office REIT universe, we had to fill in the index with some other commercial property types, particularly with industrial and retail REITs.
WMRE: Something that has come in up in conversations I have had regularly with Nareit is that if you look at office REITs, there portfolios tend to be performing better than you would expect. They tend to have highly-amenitized assets in good locations and have divested some of the weaker properties. Is that consistent with your views?
Coulter Regal: We have noticed that same dynamic. With public office REITs, the types of buildings they own and operate tend to be the ones in the more urban areas, closer to transit hubs and are high quality, newer buildings. If you look at some of the comments from some of the office REIT earning reports, one of things they mention is a bifurcation in performance of the class-A office buildings vs. lower classification office buildings—those further out, ones not near transit or older.
And some of those older buildings have begun to be demolished or repurposed. Some have discussed that there has been a lack of development starts. So, in general, office construction has slowed and older buildings may have been repurposed for other uses. That could be the basis for a future supply crunch. There’s no guarantee. But, it’s one of the points I’ve seen mentioned.
WMRE: Is this an actively-managed ETF or passive?
Coulter Regal: It’s a passive index. The goal is to target the broad universe of investible office REITs as well as the other REITs on systematic rules base. It has to be REITs that have at least 50% revenue from offices. That’s reviewed on a quarterly basis. As names move up and down, it’s also a market cap weight index with a 10% cap on its largest holdings.
WMRE: So, for example, W.P. Carey recently announced they are spinning off their office portfolio into a new REIT. That’s the kind of event that could change the ETF in the future?
Coulter Regal: Yes is pretty much the majority of their office properties that will be spun into a separate public traded REIT. W.P. Carey is included in our index as an industrial REIT. This more pure-play office REIT, if its meets our liquidity requirements, could be eligible for inclusion later.
WMRE: How long were you working on this product? When did the idea first come about and how long did it take to bring it to the market?
Coulter Regal: There were two to three months of discussions and tinkering with the index provider in building the index to approach the smaller size of the office piece. Once we were happy with the proposal, it was filed with the SEC and it’s a 75-day clock from the day you file to when you can go effective and list the product.
WMRE: Do you see this product as geared toward any specific investor class is it just for any investor that, like you said earlier, wants to invest on the directionality of the sector?
Coulter Regal: We don’t have a target audience. We have other trading vehicles that offer a similarly narrow exposure, for example, our gold miners ETF. We see everyone from retail investors all the way to hedge funds moving in and out of that. We anticipate DESK can be used by anyone in the market who wants to place a view.
WMRE: Any final thoughts?
Coulter Regal: One interesting point that we’ve been thinking about in terms of this area of the market, in part due to the depressed market share of office REITs, is that they have an attractive yield of 6%. That’s a narrow aspect. But it’s one element of the story. For investors that do have a longer-term view, one of the benefits is the above average yield. It can help mute some of the volatility that you might expect in the asset prices. It is a nice added bonus.