ETF Talk: Ripening Real Estate Recovery?

Real estate was hit hard during the recession, and the recovery of real estate prices has been shaky at best. Economic problems continue putting pressure on the sector, and an unexpected drop in May’s retail sales has a number of economists doubting the strength of a fledgling recovery.

Today’s news that housing starts fell to a five-month low in May also indicate that residential real estate remains weak. One likely reason is the April 30 end of the U.S. government’s tax incentives for home purchases. It should not be surprising that new home building dropped 10% in May to a seasonally adjusted annual rate of 593,000 units, the lowest level since December 2009, according to the Commerce Department.

But positive signs are starting to emerge. The Conference Board reported that its index of consumer confidence in the United States grew in May for the third month in a row. That reinforces my view that the slump in commercial real estate, including shopping malls and office complexes, could be about to bottom.

Recent data suggest that property values may be stabilizing. We will know more about that trend in the next couple of months, as the market will show whether it can retain housing valuations without the government’s recently expired tax credit for homebuyers. With mixed data about real estate and the economy, I am not ready to recommend the sector to investors right now. But it is one that I am watching closely.

The rapid rise of real-estate investment trusts and real estate exchange-traded funds have made it easy for individuals to gain access to low-minimum, low-cost, highly diversified real estate portfolios. Vanguard REIT Vipers (VNQ) is a large and liquid fund that boasts a low expense ratio of just 0.13%. It offers broad exposure to office buildings, shopping malls, apartment complexes, storage facilities and hotels. The fund invests in stocks issued by real estate investment trusts (REITs), companies that purchase office buildings, hotels, and other real property. The fund’s goal is to track closely the return of the MSCI US REIT Index, a gauge of real estate stocks. In addition, the fund is up more than 13% year to date. As the chart below shows, VNQ has begun to rally and it recently broke above its 50-day moving average.

Many investment professionals, including many endowment managers, advocate an allocation to real estate as part of a broad diversification strategy. Real estate traditionally has provided a hedge against inflation, as well as a cushion against equity market volatility, since it hasn’t been highly correlated with equities.

Of course, an exception occurred amid the market’s plunge in 2008-09, when real estate prices collapsed along with virtually every other asset class. But diversification of your asset holdings makes sense. The ten stocks in the table below show the fund’s biggest holdings. Those ten organizations accounted for 43.4% of the fund’s total assets as of May 31, 2010.

If you want my advice about buying and selling specific ETFs, I invite you to check out my ETF Trader advisory service. I now have six profitable trades in a row, including three double-digit percentage winners. As always, I am pleased to answer your questions about ETFs, so do not hesitate to email me by clicking here. You may see your question answered in a future ETF Talk.