A reader asks;

I am curious about your take on REIT etfs at this stage. It seems to me that as a group they have been overly beat down because of the sub-prime mess and perhaps the coming of the long awaited slow down in the economy. It avoid single stock risk, i have been thinking of putting a toe into this catagory of stocks. Any thoughts? Any best of breed insights?

A lot of people love REITs. You can find recommendations out there suggesting as much as 15 or 20% in REITs. If you do a search for lazy portfolios you will see various suggested weightings there as well.

REITs are an asset class, like most asset classes there are periods where they do very well. I think there is an element of REITs being too adored, people owning too much and the declines being very big when they happen.

The one REIT I own across the board has been hot very hard but not noticeably harder than other REITs. I have 2-3% allocation depending on the client which I consider an underweight.

One of the benefits of REITs is the low correlation to equities. iShares has two domestic REIT ETFs with long track record; IYR and ICF. According to PortfolioScience.com IYR has 0.758 correlation to the S&P 500 and ICF has 0.701 correlation. That isn’t that low. There is a closed end fund that invests in Asian real estate with ticker RAP that has a 0.486 correlation which is a little more like it. The one REIT I own has a 0.658 correlation, remember an ETF is likely to have a higher correlation than an individual name.

I am considering taking a tax loss on the one REIT I have and swapping it for something foreign, but not RAP. The logic behind possibly going foreign is the desire for a lower correlation.

The question seems to have a short term element to it. I don’t doubt that the decline in REITs is more than what us justified but to the extent they are guilty by association more decline would not be shocking. I said before I am not in a hurry to add financial exposure until the yield curve normalizes and it seems that the abnormal curve may have played a role in the REIT decline too.

Well there certainly appears to be a tight correlation there.

On something like this I think I would need to have a fundamental justification for increasing exposure. Changing it, as I plan to do, is a different matter. It is an asset class and I believe some exposure is warranted in the interest of maintaining a diversified portfolio.

Last 5 posts by Roger Nusbaum

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