After a volatile 2020, real estate ETFs are making a big comeback with a surge in capital inflows and a growing menu of options for investors.
Last year was challenging for real estate ETFs. Although the broader market of U.S. listed ETFs saw a record high of $504 billion in new money enter, real estate ETFs posted net outflows of $3.4 billion, according to CFRAs First Bridge ETF database. Uncertainty at the onset of the pandemic prompted a pullback from many real estate investors as the shutdown in offices, malls and travel sparked concerns about rent collections and net operating income. The result was a spike in selloffs in real estate ETFs and a similar surge in redemption requests in private equity real estate funds.
Capital began returning along with the roll-out of the vaccine and reopening of the economy. As of mid-July there was $7.5 billion of net inflows into real estate ETFs, according to CFRA. “Real estate is fitting in nicely between the growth and the value sectors,” says Todd Rosenbluth, head of ETF & Mutual Fund Research at CFRA, a research and analytics firm. “As the sector continues to perform as well, if not better than the broader markets, we are more likely to see continued demand for real estate ETFs.”
Among the top 25 real estate ETFs, the average return through July 23rd was 24.5 percent, which is on par with the rally underway in the publicly traded REIT According to the FTSE Nareit US All REIT Index, total returns YTD through July 22nd were at 24.8 percent.
“Real estate and REITs performed extremely poorly last year, but therein lies the opportunity,” says Jay Hatfield, CEO and portfolio manager at Infrastructure Capital Advisors LLC. “People are playing the bounce off the lows, because the sector got way oversold,” he adds. Infrastructure Capital Advisors LLC (ICA) is an SEC-registered investment advisor that manages ETFs and a series of hedge funds. Its Virtus InfraCap US Preferred Stock ETF (PFFA) is an actively managed fund that currently has 55 percent of its assets invested in REITs with the balance invested in infrastructure, industrial and financials. “PFFA is not dedicated or required to be in real estate, it’s just that we see real estate as being attractive right now,” says Hatfield.
Strong momentum for capital inflows
ETFs have emerged as a hot investment vehicle over the past few years. Growing awareness of the benefits of the investment vehicle is attracting more and more capital, and 2021 is already well on its way to smashing last year’s record. As of July 14, $490 billion of new money had been added to U.S. listed ETFs, pushing totaling AUM past $6.5 trillion. “More investors are becoming comfortable using ETFs for either broad exposure or a more tactical way of shifting towards one sector or style over another,” says Rosenbluth.
Investors and advisors like ETFs because they tend to be cheaper. They have a lower fee structures translate to better performance. Perhaps the biggest selling point is the real-time pricing. “An ETF is basically a publicly traded mutual fund,” says David Auerbach, an institutional trade at World Equity Group specializing in REITs, ETFs, preferreds, closed-end funds and new issues. People who buy or sell mutual funds have to wait until the close of the trading day for that final NAV to recalibrate. “That is a huge, huge issue, especially when you are dealing with market volatility where the market is moving several hundred points per day,” he says. Similar to public stocks, ETF price quotes are available in real time during active trading.
Real estate ETFs are capturing some of that greater market momentum. Another factor driving capital to real estate ETFs is simply yield. Global investors are on the hunt for yield, and both domestic and foreign investors like the returns they can get in the U.S. real estate market. The 10-year treasury is trading at about 1.2 percent to 1.3 percent compared to US REITs that have delivered dividends of 3 percent year-to-date, according to Nareit. Real estate is that slow and steady tortoise in the tortoise and hare scenario, and that slow and steady is going to win the race, notes Auerbach.
Yet some real estate ETFs are finding more success attracting capital than others. Some specialty real estate ETFs saw strong inflows even during the pandemic. For example, NETLease Corporate Real Estate ETF (NETL) almost doubled its AUM in the past year to more than $116 million. People lined up to go to gas stations, drug stores and fast food like Chic fil A and Dunkin Donuts, and those net lease owners were collecting 95-100 percent of their rents, notes Auerbach. “So, some of the ETFs did perform very well during 2020, but what you did see going into the back half of 2020 and into 2021 is that the ‘risk-on’ phrase went back on,” he says. Capital is returned because people wanted to capture some of the upside in rising REIT values.
Competition heats up
The real estate ETF sector is becoming more crowded. Currently, there are more than 50 real estate ETFs including three new ETFs that launched in the first half of 2021 and more than are expected to launch over the next 18 months. Part of that expansion is driven by more specialized ETFs that focus on a particular sector, such as residential, net lease or data centers.
There is the Pacer Benchmark Data & Infrastructure Real Estate ETF (SRVR), which is focused on cell tower and data center REITs and launched in May 2018. It has grown to $1.56 billion in AUM. However, it took more than two years years for Global X to launch a competing cell tower and data center ETF, which it did in October 2020. “They didn’t want to see Pacer in this little niche making all the money,” says Auerbach. GLOBAL X Data Center REITs and Global Infrastructure (VPN) has since grown to net assets of about $57.75 million. In June, Janus Henderson Group launched the Janus Henderson U.S. Real Estate ETF with a focus on real estate securities that could include cell towers, data centers, gaming REITs, cold storage and more
Real estate ETFs are finding ways to offer something unique to investors as the sector gets more crowded. “It goes back to that old Field of Dreams quote – if you build it, they will come. ETF issuers have built great, thematic ideas, and the investors have come,” says Auerbach. So, until we start churning out the same ideas with no traction, assets will continue to flow in.”
For example, Infrastructure Capital’s InfraCap REIT Preferred ETF (PFFR) is the only real estate ETF that acquires preferred REIT stock. That distinction helps the REIT stand out from its competitors. In addition, most of the securities PFFR owns are cumulative, which means that even if a company suspends its dividend, which a number of REITs did in 2020, they still owe it to those shareholders with cumulative rights. “So, it provides a margin of safety that a lot of investors are looking for, but don’t fully appreciate,” says Hatfield.
Another theme in the industry over the past two years has been growing interest in actively managed ETFs. Actively managed funds, or those that have in-house stock-picking expertise, are trying to differentiate themselves and outperform their peers with alpha returns. The three new ETFs that launched this year are all actively managed ETFs: the Fidelity Real Estate Investment ETF (FPRO); the ALPS Active REIT ETF (REIT) and the Janus Henderson US Real Estate ETF (JRE).
Auerbach believes the sector has more potential growth ahead from both domestic and international capital sources as U.S. investors convert mutual funds to ETFs, as well as sovereign wealth funds and other foreign institutions that could bring more capital to the sector. “We may only be in the third or fourth inning of REIT ETFs in the United States,” he says.