iShares Residential Eyes Safer Asset Classes

06/02/2017 2:56 am EST

Focus: ETFs

James Pearce

Director of Research, Investing Daily

The iShares Residential Real Estate Capped ETF (REZ) seeks to track the investment results of an index composed of U.S. residential, healthcare and self-storage real estate equities, explains Jim Pearce, editor of Investing Daily's Personal Finance.

The fund consists of 40–50 holdings intended to provide exposure to the U.S. residential real estate sector by owning real estate investment trusts (REIT) that invest directly in residential properties.

When we first wrote about this fund six months ago, we noted that it had outperformed 99% of its REIT peers over the previous five years because of its concentration on residential property.

With the unemployment rate at a ten-year low and wages growing faster than inflation, residential property values are continuing their upward surge as buyers bid up home values.

This dynamic also pushes apartment rents higher, since steeper home prices combined with rising interest rates means bigger mortgage payments for new home buyers. Either way, this ETF wins since it can select which type of REIT to emphasize depending on prevailing market conditions.

A potential concern is the health care portion of the portfolio, which comprises 35% of total assets. The fund also has 17% of its assets invested in “specialized” REITs consisting primarily of self-storage facilities.

Of course, the huge “x-factor” is President Trump’s proposed income tax overhaul plan. Under the proposed version of the plan, the deduction for home mortgage interest payments would remain.

In that case, demand for residential property could escalate if mortgage interest becomes one of the few itemized deductions available. We may see a big uptick in the value of residential REITs later this year, including many of the ones owned by this fund.

If Trump’s income tax overhaul never comes to pass, the stock market correction that would likely ensue could cause nervous investors to pull money out of intangible assets like stocks and bonds and into the one asset that they can see and touch every day—residential real estate.

And even without a correction, traditional bond buyers may take a closer look at REITs because rising interest rates will push bond prices lower.

Given those circumstances, residential real estate may be one of the few asset classes that perform well no matter how the economy plays out over the remainder of this year.

The past eight years have often been referred to as the least loved bull market ever, and it may soon be coming to an end. When it does, many investors will seek somewhere less risky to put their money.

Residential real estate will most likely be one of the first places they look to diversify their portfolios, and this ETF already owns many of the properties they will be buying.

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