2023-04-04 10:11:49 ET
Summary
- EWRE invests in real estate companies listed in the S&P 500 index, with an equal weighting given to each stock in the portfolio.
- Rising interest rates pose challenges for REITs.
- EWRE is a Sell for now. The REIT sector is facing cyclical headwinds and the long-term alpha potential is lacking.
By Kemerey Black
The Invesco S&P 500 Equal Weight Real Estate ETF (EWRE) lacks appeal due to the recent turmoil in the banking sector and doubts about the effectiveness of REITs as an inflation hedge. REITs may hedge against inflation by passing on rising costs to their tenants through increased rental income. Additionally, as input costs rise, the value of existing properties tends to increase, making it difficult for new properties to be constructed and thus limiting new supply. Amidst the current climate of elevated and increasing interest rates, the capital-intensive nature of REITs may negate any potential advantages they offer.
Furthermore, the REIT sector has historically lagged behind the broader equity market in terms of long-term performance. There are just too many headwinds and innate disadvantages for this sector in the current environment. I rate EWRE a Sell.
Little Going Right for REITs in 2023
The recent drop in the REIT sector, amidst a broader financial sector selloff stemming from recent bank failures, has rendered valuations more attractive. However, REITs remain vulnerable to continued downward pressures. The Federal Reserve increased rates by another quarter point in March, grappling with the challenge of balancing the fight against inflation with the banking turmoil and a potential recession. The Federal Open Market Committee ((FOMC)) softened its forward guidance to "some additional policy firming may be appropriate". This could be a future pause in rate hikes or continued hiking. If the Fed persists with rate hikes, it could lead to a further increase in the cost of capital, impacting the profitability of EWRE's underlying companies.
Pros and Cons of Equal-Weighting in The Current Investment Climate
EWRE invests in the 30 real estate companies in the S&P 500, with each stock given an equal weighting in the portfolio. Despite the equal-weighted methodology, EWRE is exposed to significant single-stock risk, as each stock has at least 3% weight and the performance of any individual stock could significantly impact the returns of the entire portfolio.
Compared to a market-cap-weighted ETF, EWRE is currently underweight in tech REITs (such as cell towers and data centers) and industrial REITs. While this underweighting has harmed returns in recent years, it may prove advantageous in the current market environment where tech valuations are under scrutiny.
Bear Case
Increasing financing costs impacted real estate returns in 2022. When interest rates rise, it can increase the cost of borrowing for REITs and reduce their profitability. If interest rates increased beyond current market expectations, this could weigh on EWRE's returns.
In February, retail sales experienced a slowdown as inflation caused consumer wallets to thin. With the rise of hybrid work environments, the growth of office employment has been hindered, potentially impacting demand for commercial real estate. These and other factors could contribute to a reduction in demand for commercial real estate and ultimately weigh on the return potential of EWRE.
Furthermore, as interest rates rise, fixed-income investments can become more attractive to investors, which can reduce demand for REITs. This is because REITs are often viewed as a hybrid between stocks and bonds, and when bond yields rise, investors may shift their focus towards fixed-income investments with less risk and more predictable returns.
Bull Case
While EWRE may lag the broader equity market over the long term, it may provide valuable diversification by adding exposure to the real estate sector and potentially reducing overall portfolio risk. According to NAREIT: "Listed REITs help to diversify a portfolio because, as real estate, they are a distinct asset class that has demonstrated low-to-moderate correlation with other sectors of the stock market, as well as bonds and other assets. In other words, REIT returns have tended to zig while returns of other assets have zagged, smoothing a diversified portfolio's overall volatility." Given the current uncertain market conditions, investors might seek to mitigate portfolio risk by considering ETFs like EWRE.
Price Trend Analysis
The declining moving average lines of EWRE suggest that investors should exercise caution as there is a possibility that the stock may continue to trend downwards. Notably, the 20-day and 200-day moving average lines are currently in decline, indicating a potential bearish sentiment in the market. I'll be more optimistic about REITs when the market starts to signal that it is preparing to buy them in earnest again. That time is not now.
Investment Opinion
While EWRE's current valuation may appear relatively attractive, as it is currently down over 30% from its 52-week high, it is important to note that the real estate sector as a whole is struggling with higher debt service costs. A continued price decline could reach a favorable entry point for EWRE. But for now, I rate EWRE a Sell.
For further details see:
EWRE: Struggle With Rising Interest Rates Likely To Hinder This ETF's Performance