Is It Time to Overweight the Real Estate Sector?

Good day traders.

Here at Aspen we have been looking at how much weight to give the Real Estate sector in our S&P 500 benchmarked model portfolio. In the last year, real estate has under-performed most sectors.


Since last year’s loser can often become this year’s winner, we decided to dig in and see if it is time to overweight Real Estate in our model portfolio or if there are opportunities in the real estate sector, specifically REITS or a real estate ETF. In short, on both a fundamental and technical basis we believe there are better opportunities elsewhere.

Factors that affect valuation

A very common way to invest in the real estate market is through REITS (Real Estate Investment Trusts).  REITS are valued based on their funds from operations, known as FFO or AFFO. Funds from operations will likely grow as the economy stays strong. The value of the REIT is also influenced by a capitalization rate. Interest rates also play into the equation and tend to lower valuations as they rise. As we are in a rising interest-rate environment, REIT valuations are negatively affected.

Offsetting this, somewhat, is the effect of tax reform. According to the Wall Street Journal, “The (tax) plan allows investors to deduct 20% of the income, with the remainder of the income taxed at the filer’s marginal rate. […] Shareholders of REITs who now pay the top income-tax rate of 39.6% on dividends received would see that rate drop to 29.6%.” This more attractive tax scenario should increase the demand for REITS, thus driving up prices.

Another confounding issue is the relative performance of different types of real estate. Retail REITS have been struggling and will likely continue to struggle, whereas REITS that lease towers, storage space, and server space are doing well.

At this point we have a dilemma on multiple fronts. The negatives: rising interest rates and retail slowdown. Positives: demand for towers, storage space, server space, and tax reform. Which one wins? Well, we turned to the technical analysis.

The Technical Picture

To us, fundamentals, while important, are a lousy timing vehicle. While our fundamental analysis suggests increasing the weighting in Real Estate, technically that makes very little sense to us.

If we look at GQRE the contracting price action into the later half of 2017 suggests topping price action.

  • The recent break lower violated the lower trend-line
  • The corrective rally back up stalled right at a typical Fib retracement level .618 or $63.39
  • If anything, prices are poised to move lower

Next we look at IYR. To me it is a pretty basic set-up that does not inspire a bullish view:

  • Very choppy price action higher off 2016 lows
  • Recent break lower of lower trend-line
  • Looks like lower levels to me.

Remember, price is everything….period. To me, these charts do little to inspire a bullish view.

So, you might be wondering why we don’t further reduce the exposure if the charts look awful?

Well, the charts are a bit neutral overall with a modest downside look and feel to them. You could have made the argument many times in the last year that prices were poised to move lower….yet ended up getting clipped.

Sometimes it is simply OK to be neutral.

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Our Conclusion – Do Not Overweight

The result of our analysis is ambivalent. While the economy is strong on some fronts (ex-brick-and-mortar-retail) there are negative factors that will limit the performance of the real estate sector. We do not see a case for overweighting real estate at this point in time. We do feel that international developed markets may present a more attractive real estate picture as the European, Asian, and Australasia economies have trailed the US in their recovery. We may incorporate a weighting to these markets in our model portfolio.

Where are the better opportunities on a sector and individual security basis? Stay tuned to Aspen and we will have more guidance for you.

Showing 4 comments
  • george ross

    I think maybe the question should be is it time to overweight the Energy sector that was the dog on the chart above

  • Dave Floyd

    George – that is a great point. Energy was the worst performing sector in 2017 and is definitely showing signs of life. That analysis is on our radar and we will have it for you soon. Stay tuned.

  • Dave Floyd

    Further to your point. Building longs in XLE on pull-backs towards $73.13-$71.00 with fairly tight stops under $70.50

  • Dave Floyd

    Have to say….today’s price action is favoring a bearish view. Some key levels breached in IYR, RWR etc etc.

    Also note that 10-year rates broke higher today……that is NOT GOOD for real estate….getting interesting

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