Can REITs Defy the Real Estate Slump?

After two subpar years of market performance and slumping property prices, real estate stocks are inexplicably up. How much longer will they continue to defy all odds? Over the past two years, commercial real estate prices have fallen around 40%, which surpasses the last crash in property prices two decades ago. But real estate stocks seemingly have a mind of their own.

As a group, U.S. real estate investment trusts, also known as “REITs,” have climbed 10% in value since the beginning of the year and other sub-segments are handedly outperforming key stock benchmarks like the S&P 500 (NYSEArca: SPY) and the Dow Jones Industrial Average (NYSEArca: DIA).

REITs cover various segments of the real estate market including apartments, hotels, industrial properties, medical facilities, shopping malls and offices.

Let’s evaluate real estate ETFs tracking some of these areas.

iShares Dow Jones U.S. Real Estate Index Fund (NYSEArca: IYR)

IYR is benchmarked to the Dow Jones U.S. Real Estate Index. The index measures the performance of the real estate industry within the U.S. equity market, including real estate holding and development companies along with real estate investment trusts (REITs) subsectors. IYR has $1.3 billion in assets.

Year-to-date*, IYR has climbed 15.45% and the fund carries a 8.4% dividend yield. In 2008, IYR fell 39.99% and the fund’s annual expense ratio is 0.48%.

SPDR DJ International Real Estate ETF (NYSEArca: RWX)

The performance and yield of RWX is linked to the Dow Jones Global Ex-US Select Real Estate Securities Index. The fund's index is float adjusted market capitalization weighted and designed to measure the performance of publicly traded real estate securities in developed and emerging countries excluding the United States. RWX has just over $600 million in assets.

So far this year, RWX has climbed 24.78% and the fund carries a 4.9% dividend yield. In 2008, RWX fell 51.11% and the fund’s annual expense ratio is 0.60%.

iShares FTSE NAREIT Industrial/Office Index Fund (NYSEArca: FIO)

FIO is tied to the FTSE NAREIT Industrial/Office Index, which tracks industrial and office real estate stocks in the U.S. market. Top holdings include Boston Properties, Duke Realty, Mack Cali Realty and ProLogis.

So far this year, FIO has climbed 14% and the fund carries a 6.4% dividend yield. In 2008, FIO fell 48.39% and the fund’s annual expense ratio is 0.48%.

Claymore/AlphaShares China Real Estate ETF (NYSEArca: TAO)

TAO follows the AlphaShares China Real Estate Index. The primary criteria for selecting a company for inclusion in the index is that the company derives a majority of its revenues from real estate development, management or ownership of property in mainland China or the Special Administrative Regions of China such as Hong Kong and Macau. Index holdings must have a market capitalization of $500 million or greater for consideration.

So far this year, TAO has climbed 64% and the fund carries a 2.2% dividend yield. In 2008, TAO declined 56.98% and the fund’s annual expense ratio is 0.65%.

The Future for Real Estate Stocks

According to Colliers International, office vacancies are now at 15.4% through the second quarter and up from last year. Other parts of the real estate market remain weak, particularly those like hotels and shopping malls, which are closely tied to consumer spending.

Property prices are being hurt by falling rental income which is exacerbating declines in value. As tenant vacancies rise, rental income declines making properties less valuable than the prices they were financed at.

Some property managers find themselves at the mercy of the rental market. When leases expire and come due for renewal, managers are forced to cut rents just to keep tenants from leaving. Many landlords have no choice but to helplessly watch their cash flows dwindle.

Did real estate prices really bottom as some analysts suggest? This is a burning question that has all real estate investors on the edge of their seats. If lower property prices are still ahead, the share prices of real estate stocks may eventually wake up to this reality. Until then, only time will tell.

Disclosure NONE.