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After solid rebound, what’s next for small-cap REITs?

August 2, 2018

This undated photo provided by New York Life Investments shows Sal Bruno, chief investment officer with IndexIQ. Real estate stocks rebounded in the second quarter as investors jittery over escalating global trade tensions and the impact of a stronger dollar favored smaller, more domestically focused companies. Bruno, chief investment officer at IndexIQ, recently talked about IQ's Real Estate Small Cap ETF and made the case for why small-cap REITs may make another comeback this year. (New York Life Investments via AP)

Real estate stocks rebounded in the second quarter as investors jittery over escalating global trade tensions and the impact of a stronger dollar favored smaller, more domestically focused companies.

The trend began in March, when the Trump administration announced tariffs on imports of steel and aluminum. In response, traders bid up shares in small-cap stocks, driving the Russell 2000 index of smaller companies sharply higher. Small-cap real estate stocks also got a boost.

One example is IndexIQ’s US Real Estate Small Cap ETF (ROOF). The exchange-traded fund, which aims to track the overall performance of small-cap U.S. real estate companies, posted a gain of 11.2 percent in the past three months. In the same period, the S&P 500′s real estate sector gained 8 percent, while the S&P 500 rose 6.5 percent.

Small-cap REITs and other smaller-company stocks have given back some of their gains this past month. Some investors may be reconsidering the view that smaller U.S. companies may in fact fare better than larger, multinational companies in the face of tariffs or other obstacles to trade.

Sal Bruno, chief investment officer at IndexIQ, recently talked about IQ’s Real Estate Small Cap ETF and made the case for why small-cap REITs may make another comeback this year. Answers have been edited for clarity and length.

Q: What kind of companies make up of this fund?

A: The way we’ve constructed our index is to basically take the bottom 10 percent of the U.S.-listed REITs. You don’t get excessive concentration on any individual sectors. That’s a key part of why we’ve seen the volatility be a little bit more in line with the large caps, despite the fact that small caps tend to have a higher volume in general.

Q: What’s the advantage of a fund that focuses on small-cap real estate companies?

A: Small-cap REITs ETFs have actually outperformed large-caps both in the immediate past and also a longer time period as well. Typically, you’re taking on more volatility in small caps than you are in large caps, and you hope to get compensated with a return for that extra risk. In this case, it’s actually the best of both worlds, in the sense that (the fund) has gotten better returns at about the same level of risk.

Q: Real estate stocks are generally not having a good year. Interest rates have been rising, which can make REITs less attractive to dividend investors. Is this a good time to invest in real estate stocks?

A: Clearly the Fed is on a path to raise rates on the short end and has been doing so since the end of 2015, but if you look at how REITs have performed since (short-term rates) started moving up basically from zero up to about 2 percent where they’re at now, REITs have actually been up about 25 percent cumulatively over that time period, so they’ve demonstrated that they can actually weather the short-term interest rate climb.

We’re still constructive on REITs over the second half of the year. If you look at where they’re yielding right now they’re still at about 5.5 percent on the small caps, which is a fairly attractive yield relative to what you’re getting elsewhere. We think there’s still more room to grow, but investors should be cautious and look at the risk involved.

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