While the annual yield on two-year Treasury bonds sits at a paltry 0.37%, investors can earn an average yield of about 4% by investing in REITs. Some REIT niches, like health care facilities, pay even more.
As investors flooded into these investments, lemming-style you could say, most REITs showed dramatic percentage price increases. I’m talking between 120% and 180% over about 15 months, from March 2009 through mid-2010.
Knowing great things don’t last forever, many of the early investors locked in their gains in late 2010. And high prices scared off many latecomers, who were looking to get in on the action but afraid to buy such a toppy market. That resulted in the REIT space treading water for a couple of years.
The chart below shows it best. It’s a ratio chart of the Vanguard REIT Index ETF (VNQ) and the S&P 500 (SPY).
I’ve chosen to judge VNQ relative to SPY, rather than on its own, because it helps to cancel out the effect of broad market swings between risk-on and risk-off environments. Both REITs and the S&P 500 tend to move higher when investors are confident. My aim, when creating this chart, was to highlight the periods during which REITs outperformed the market.
As you can see, the ratio line moves sideways from late-2010 through the first quarter of 2013. Then the ratio dropped sharply as overextended REITs sold off.
Yet this trend is far from over.
Persistently low interest rates – the primary factor in the outperformance of REITs – are still here. And we expect low interest rates to persist through 2014.
That makes buying REITs now a great play, because most of the excessive price appreciation has been worked off over the last several months.
I’ve drawn a Fibonacci retracement grid on the ratio above – the green line – showing it has just hit the all-important 50% level. This is where we see good dip-buying opportunities within upward trending markets.
If you’re looking for an easy way to get into the REIT space, a diversified ETF, like Vanguard’s REIT Index ETF (NYSE: VNQ) is a good way to go.