The real estate sector is struggling so far in 2023 and is the only sector out of the 11 in the S&P 500 to lag the benchmark. After a strenuous 2022, U.S. real estate stocks are expected to remain under pressure this year against the backdrop of credit tightening by the banks on top of already high interest rates.
According to a Reuters article, the S&P 500 real estate sector experienced a 28% slump in 2022. Although the sector has managed to gain about 1% in 2023, it has still underperformed in comparison to the overall S&P 500, which has risen by 8%.
The recent upheaval in the banking sector, caused by the collapse of the Silicon Valley Bank in March, has added to the sector’s difficulties. With banks becoming more stringent with lending terms, securing debt for real estate companies will become challenging.
Since SVB's troubles were made public on Mar 8, the real estate sector has declined by 2%, while the S&P 500 has risen by 4%. Since the regional banking crisis in March, the S&P 1500 office REITs index has fallen by 16%, with some stocks witnessing an even sharper fall.
Commercial Real Estate Woes
With the surge in remote working since the COVID-19 pandemic, some of the largest U.S. banks are increasingly worried about the state of commercial real estate (CRE), citing it as an area of growing concern. Per a Reuters article, amid a slowing economy and rising interest rates, the commercial real estate sector is facing tougher conditions as property values continue to decline and more borrowers struggle to repay their loans, leading to an overall deterioration in the industry.
With banks accounting for more than half (54%) of the $5.7 trillion CRE market, the industry is likely to face a daunting challenge in the coming years. CRE loans of around $1.4 trillion are due by 2027, with nearly $270 billion of that amount maturing this year alone, increasing the expectation of higher commercial real estate loan losses.
What Lies Ahead for the Real Estate Market?
The real estate sector’s future performance will be heavily influenced by the trajectory of interest rates. As rates increase, the stable cash flows generated by commercial properties become less appealing, and the stocks in the market segment tend to underperform.
The negative impact of the Federal Reserve’s interest rate hikes on the real estate market was evident from the performance of the sector last year. With the market expecting one more interest rate hike by the Fed in its next meeting, the path of the sector remains uncertain.
However, if the Fed implements a pause later this year, the real estate segment may improve. Then too, the well-being of the sector will depend on the health of the U.S. banking sector.
ETFs in Focus
Against this backdrop, real estate ETFs like Vanguard Real Estate ETF VNQ and Real Estate Select Sector SPDR Fund XLRE may come under pressure as long as the regional banking health is not in good shape.
However, investors can play inverse/leveraged real estate ETFs like ProShares UltraShort Real Estate SRS, Direxion Daily Real Estate Bear 3X Shares DRV and ProShares Short Real Estate REK to reap smart gains if there is a decline in real estate ETFs.
Some of the mentioned ETFs are highlighted below.
Any Caveat of Inverse/Leveraged ETF Investing?
Investors should note that these products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing — when combined with leverage — may make these products deviate significantly from the expected long-term performance figures.
Vanguard Real Estate ETF (VNQ)
The fund seeks to track the performance of the MSCI US Investable Market Real Estate 25/50 Index, which is made up of stocks of large, mid-size, and small U.S. companies within the real estate sector. The fund has 165 securities in its basket with Vanguard Real Estate II Index Fund Institutional Plus Shares taking the top spot, holding 12.39% of the fund, followed by shares of Prologis Inc. PLD and American Tower Corp. AMT, each having a share of 8.05% and 6.65%, respectively.
VNQ has the largest asset base in this category, with $32.06 billion. The fund charges an annual fee of 0.12% and trades in a daily average volume of about 6.1 million shares. It has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook. The fund has given negative returns of 21.69% over the past year but has gained 4.27% in the past month.
Real Estate Select Sector SPDR Fund (XLRE)
The fund provides investment results that generally correspond to the performance of the Real Estate Select Sector Index. The fund has a basket of 30 securities with Prologis Inc. (PLD) and American Tower Corp. (AMT) being the top two holdings, having a share of 13.08% and 10.97%, respectively.
Having gathered an asset base of $4.52 billion, the fund trades in a daily average volume of about 6.18 million shares. XLRE charges an annual fee of 0.10% and has a Zacks ETF Rank #3 (Hold) with a High risk outlook. The fund has fallen by 21.58% over the past year but has gained 4.48% in the past month.
ProShares UltraShort Real Estate (SRS)
The fund seeks daily investment results that correspond to two times the inverse of the daily performance of the S&P Real Estate Select Sector Index, which represents the real estate sector of the S&P 500 Index. SRS has 30 holdings in its basket, with Prologis Inc. (PLD) taking the top spot with 13.10% of the fund.
It has gathered an asset base of $59.29 million. The fund charges an annual fee of 0.95% and trades in a daily average volume of about 128,400 shares. Having a High risk outlook, SRS has given positive returns of 38.59% over the past year.
Direxion Daily Real Estate Bear 3X Shares (DRV)
The fund seeks daily investment results of 300% of the inverse of the performance of the Real Estate Select Sector Index. Having an asset base of $165.60 million, DRV charges an annual fee of 1.08%. It trades in a daily average volume of about 629,500 shares and has a High risk outlook. The fund has given positive returns of 50.7% over the past year but has declined 13.28% in the past month.
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