ETF Update: Time For REITS?

Sometimes price action seems inconsistent with the fundamental story.  One of the ways we use our ETF rankings is to highlight developments that deserve further investigation.

While financial sectors in general earn continued strong ratings, the most noteworthy feature of the new ratings is the rapid rise of two Real Estate Investment Trust (REIT) ETF’s.  (The complete current rankings are at the end of the article, along with an explanation of our methodology).

Surprising REIT Strength

Investors who choose REIT’s general seek high yield and tax advantages.  The REIT must return 90% of income to unit holders to avoid taxation at the trust level.  Since certain non-cash expenses like depreciation reduce income, investors determine value as a multiple of adjusted funds from operations (AFFO) rather than a PE multiple.  The REIT provides smaller investors the opportunity to add real estate of various types to their portfolios without directly buying properties.  (Those interested in learning more about REIT’s, valuation, and taxation can find a good start on the subject, including many specific articles by experts, at Investopedia.

The most obvious risk in REIT investing comes when there is reduced performance from the properties held in the trust.  The economic impact on commercial real estate has placed REIT shares among the worst performers performers  since last October’s turning point.

More recently, there has been a rebound.  Sameer Bhatia of Dow Jones writes as follows:

REIT shares have rallied between 30% and 60% over the last month despite continued weak retail sales, rising vacancies, structural overcapacity in the sector, staggering debt loads and significant refinancing risk at some of these companies.

Why the current strength?  Is there an opportunity for the ETF investor or trader?

REIT ETF’s

We evalute REIT’s through the iShares Cohen & Steers Realty Majors Index Fund (ICF) and the iShares Dow Jones U.S. Real Estate Index Fund (IYR).  Both are currently in the top eight of our rankings, but we will focus on 2nd-ranked ICF, up from #29 last week.

ICF has reasonable diversity with 25% of the fund in five names and about 40% in the top ten.  Since the trusts are all very similar, this can be deceptive.  The beta for the group is about 1.6.

The chart below clearly shows the collapse last autumn, as well as the recent strength.

Reasons for the Rebound

The Dow Jones article cited above suggests an interesting reason for REIT strength, the potential for acquisitions.

Leading REITs such as Simon Property Group Inc. (SPG), Public Storage (PSA) and Vornado Realty Trust (VNO) can acquire the senior secured debt, or the mortgage notes securing assets, of their weaker competitors at their current discounted prices and then simply wait for these companies to sink under the weight of their own debt. This could prove a unique win-win strategy for well-capitalized companies looking to acquire others.

If the target company does default, it would give the acquirer a strong negotiating position and make it the leading contender to take possession of the assets of the defaulting company

We note that the leaders named in the article are also the top holdings in ICF.

Mark Jewell of the Associated Press, has a different slant.  His story, Opportunity abounds in battered REIT market, highlights the attractive yields after the collapse in prices.

Some see the REIT rally as just a part of the general market rebound.

Traders Drawing a Line

Two noted trading authorities are skeptical about IYR.

David Fry (not mentioning closely-related ICF) sees “clear resistance” for IYR.  Be sure to check out his charts with notes.

Maoxian sees a return to the March lows as part of a textbook setup with broader market implications.  Check out his chart.

Our Take

This is a very interesting question.  While we trade by following our model, it is wise to be aware of all viewpoints.  It is part of the process of improving methods.

Weekly TCA-ETF Rankings

47 of our 57 sectors are in the “buy” range.  Many sectors still have extremely strong ratings, although some energy and health care ETF’s have moved into our “penalty box”.  This designation means that the sector cannot qualify as  “buy” on technical grounds.  You can think of it like a sell stop, only with a more complicated basis.

It was another excellent week for the system, gaining over 4 percent and beating the S&P (^GSPC) by more than 2.5%.

Based upon the model signals, we continue our official bullish position in the Ticker Sense Blogger Sentiment poll.

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