Commercial real-estate worries weigh down property ETFs — but a ‘durable’ corner holds up relatively well

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Exchange-traded funds with exposure to commercial real estate have slid this month, with the recent volatility in bank stocks exacerbating concerns over the property market.

The Vanguard Real Estate ETF
VNQ,
+1.05%,
Schwab U.S. REIT ETF
SCHH,
+0.95%
and Real Estate Select Sector SPDR Fund
XLRE,
+1.08%
have significant exposure to commercial real estate, although the funds are diversified across various types of properties, said Aniket Ullal, head of ETF data and analytics at CFRA Research, in a phone interview.

All three have losses so far in March and for the year, struggling to recover from a bruising 2022 for markets as the Federal Reserve rapidly hiked interest rates to tame high inflation. Shares of both the Vanguard Real Estate ETF and Real Estate Select Sector SPDR Fund plunged almost 29% last year, while the Schwab U.S. REIT ETF tumbled nearly 27%, according to FactSet data.

“The pocket of opportunity within commercial real estate is the publicly-traded REITs,” said Greg Kuhl, portfolio manager for the global property equities team at Janus Henderson Investors, in a phone interview, referring to real estate investment trusts. “Public REITs are only 10% of commercial real estate overall.”

Investors have been worried about commercial real estate after recent regional bank failures and “stress in the financial system,” but compared with public REITs, private owners tend to borrow more based on the percentage of debt used to fund their property purchases, according to Kuhl.

 Read: Commercial real estate, smaller banks face ‘doom loop’ risk, warns Capital Economics

Also see: Commercial mortgages are a big $3.1 trillion share of bank holdings: Goldman Sachs

Industrial properties appear to be a bright spot within commercial real estate. 

CFRA’s equity analysts are still “bullish” on companies found in the industrial area, said Ullal, pointing to the top two holdings of the Pacer Industrial Real Estate ETF
INDS,
+1.53%,
Public Storage and Prologis Inc., as examples. Public Storage
PSA,
+1.32%
and Prologis
PLD,
+1.49%
each represent around 15% of the fund’s holdings as of Thursday, according to portfolio data on the fund’s webpage. 

The Pacer Industrial Real Estate ETF
INDS,
+1.53%
has surpassed S&P 500 gains so far this year, up 6.4% through Wednesday despite a 3% decline in March through the same date, according to FactSet data. The SPDR S&P 500 ETF Trust
SPY,
+0.58%
had a year-to-date gain of about 5% over the same period. 

‘Big red flag’

Commercial real estate includes other types of properties such as offices, apartments and retail as well as industrial.

“Office exposure is a concern across the board,” according to Kuhl. “We’re running at about 50% of pre-COVID office attendance in the U.S.,” he said. “That’s a big red flag in terms of future demand.”

Read: Office property woes could be tip of iceberg if credit freezes up as $1 trillion bill comes due

Kuhl, who expects offices to be the “main area” for problems within commercial real estate, says that he likes industrial as a property type.

“We think that it has the best fundamentals in commercial real estate,” he said, citing “very high” occupancies. “We think it’s going to be really durable, even in a slower economic environment because there’s structural trends at play,” he said, explaining that companies are continuing to “build out their e-commerce fulfillment capabilities, which requires a lot of warehouse space.”

Meanwhile, concern over “banking issues” led to March weakness for the Janus Henderson U.S. Real Estate ETF
JRE,
+1.91%,
said Kuhl, along with larger real estate ETFs with commercial real estate exposure.

Shares of the Vanguard Real Estate ETF, which has $31 billion in assets under management, have dropped 6.4% this month through Wednesday, bringing its 2023 losses to 2.7%, FactSet data show. 

The Schwab U.S. REIT ETF, with $5 billion in assets under management, has fallen 5.7% over the same period this month for a year-to-date decline of 2.3%. And the Real Estate Select Sector SPDR Fund’s 5.5% drop this month has left the $4 billion fund with 2.2% losses this year through Wednesday.  

Janus Henderson U.S. Real Estate ETF, an actively managed fund, is beating the much larger Vanguard Real Estate ETF, Schwab U.S. REIT ETF and Real Estate Select Sector SPDR Fund based on year-to-date performance. 

The Janus ETF, which has around $5 million of assets, had gains of 1.6% this year despite sinking 6.1% in March through Wednesday, according to FactSet data. Kuhl is a co-portfolio manager for the fund. 

“There’s much more exposure to office in private real estate than there is in public,” said Kuhl.  Also, “public REITS really don’t use the bank debt market” much, he said.

They typically turn to the corporate bond market for debt financing, as opposed bank loans or commercial mortgage-backed securities, according to Kuhl, who said a high percentage of the total market value for U.S. public REITs is tied to investment-grade ratings.

“REITs are usually well capitalized,” said Rich Hill, head of real estate strategy and research at Cohen & Steers, in a phone interview. “They have access to the senior unsecured bond market.”

BlackRock’s iShares Cohen & Steers REIT ETF
ICF,
+0.97%,
which tracks an index of large-cap REITs and has around $2 billion of assets under management, was down 2.2% this year after falling 5.1% this month through Wednesday, FactSet data show. 

The fund’s benchmark is the Cohen & Steers Realty Majors Index. Equinix Inc.
EQIX,
+0.64%,
Prologis and American Tower
AMT,
+1.39%
were the ETF’s top three holdings as of Wednesday, according to data on BlackRock’s website.

While properties such as offices have been under pressure, Hill said that other property types such as industrial and healthcare appear in “pretty good shape” after a rise in property valuations over the past five to 10 years.

As usual, here’s your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good…

… and the bad

New ETF

Simplify Asset Management announced March 28 that it launched the Simplify Commodities Strategy No K-1 ETF
HARD,
+0.42%,
designed to provide investors a core commodity holding and a hedge against inflation.

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