Nirian
Investment Thesis
Vanguard Global ex-U.S. Real Estate ETF (NASDAQ:VNQI) is a sell due to poor macro-level prospects for international real estate investment holdings. While the fund has a low expense ratio, substantial dividend yield, and a high amount of diversification, its poor performance has negated these positive qualities. Looking forward, investors will likely see better performance in international funds that are broadly diversified among multiple sectors.
Fund Overview and Compared ETFs
VNQI is an ETF that seeks to track the S&P Global ex-U.S. property index. With its inception in 2010, the fund has 655 holdings from approximately 30 different countries. VNQI is a relatively large exchange-traded fund with $3.74B in AUM. VNQI consists of predominantly Pacific holdings (49.80%), followed by European holdings (23.70%) and emerging markets (20.40%). Specifically, VNQI’s largest weights by country are in Japan (23.50%), Australia (11.50%), Hong Kong (8.10%), and the United Kingdom (7.60%).
For comparison purposes, other funds examined are the SPDR Dow Jones International Real Estate ETF (RWX), the iShares International Developed Property ETF (WPS), and the iShares International Developed Real Estate ETF (IFGL). These other ETFs were selected based on their similar objective of seeking returns through international real estate holdings. Each compared fund varies slightly in sub-industry and national weights. For example, RWX is heavier on holdings in Japan (31.37%) and UK (14.07%) while WPS is heavier than VNQI on holdings in Hong Kong (9.82%) and Singapore (8.15%).
In addition to real estate investment trusts, the compared funds also include real estate operating companies or REOCs. REOCs differ from real estate investment trusts, or REITs, in that they reinvest more of their earnings back into the growth of their business. Therefore, a fund including a large amount of REOCs should expect to see greater capital appreciation at the expense of income generation compared to a REIT.
Performance, Expense Ratio, and Dividend Yield
Despite broad international diversification, VNQI and all compared funds have seen negative performance over the past decade. VNQI’s average annual return over the past five years is -3.01%. By comparison, RWX has an average 5-year -3.58%, WPS has an average 5-year return of 0.11%, and IFGL an average 5-year return of -0.58%. All of these funds underperformed most U.S. domestic real estate ETFs as well as broad-based, multi-sector international funds.
10 Year Total Price Return: VNQI and Compared International Real Estate Funds (Seeking Alpha)
VNQI has the lowest expense ratio compared to peer funds examined at 0.12%. Additionally, the fund has a strong dividend yield of 3.78%. However, the dividend yield for both VNQI and peer funds has been declining over the past five years. For real estate funds, this declining dividend yield also typically leads to fund outflows and share price decline as one of the primary qualities of real estate funds is their dividend yield.
Expense Ratio, AUM, and Dividend Yield Comparison
|
VNQI |
RWX |
WPS |
IFGL |
|
|
Expense Ratio |
0.12% |
0.59% |
0.48% |
0.48% |
|
AUM |
$3.74B |
$304.73M |
$37.06M |
$117.14M |
|
Dividend Yield TTM |
3.78% |
3.92% |
2.77% |
2.39% |
|
Dividend Growth 5 YR CAGR |
-8.05% |
-11.09% |
-13.04% |
-14.73% |
Source: Seeking Alpha, 2 Apr 24
VNQI Holdings and Factors Impacting Its Outlook
VNQI has the greatest amount of diversification of peer international real estate funds with 655 holdings. It is also the least concentrated on its top 10 holdings with 21.03% weight. Because each of the compared funds has similar objectives, there is a high amount of similarity in their holdings (bolded in the following table).
Top 10 Holdings for VNQI and Peer International Real Estate Funds
|
VNQI – 655 holdings |
RWX – 123 holdings |
WPS – 363 holdings |
IFGL – 262 holdings |
|
GMG – 3.72% |
8801 – 7.50% |
GMG – 5.26% |
GMG – 6.37% |
|
8801 – 2.81% |
SGRO – 3.80% |
8801 – 4.16% |
8801 – 4.49% |
|
VNA – 2.51% |
SCG – 2.86% |
VNA – 3.33% |
VNA – 3.22% |
|
8802 – 2.24% |
823 – 2.75% |
8802 – 3.31% |
8802 – 3.07% |
|
1925 – 2.10% |
URW – 2.03% |
1925 – 2.69% |
SGRO – 2.38% |
|
16 – 1.68% |
C38U – 1.85% |
8830 – 2.43% |
8830 – 2.29% |
|
8830 – 1.56% |
A17U – 1.82% |
SGRO – 2.11% |
16 – 2.14% |
|
EMAAR – 1.51% |
SPSN – 1.80% |
16 – 2.00% |
SCG – 1.80% |
|
SGRO – 1.50% |
8951 – 1.69% |
SCG – 1.58% |
823 – 1.72% |
|
823 – 1.40% |
LEG – 1.58% |
823 – 1.52% |
URW – 1.29% |
Source: Multiple, compiled by author on 2 Apr 24
As discussed, the long-term performance of each of the international real estate funds has been negative. While this is rearward-looking, I believe this trend will continue for the next few years. This is based on multiple macro-level factors discussed in further detail below.
Why International Real Estate Holdings Are Struggling
REIT and REOC returns are dependent on a variety of factors including interest rates, inflation, and geopolitics. However, perhaps the greatest propellant for a real estate company’s increase in value is economic expansion. China, the world’s second-largest economy, saw roughly half of its top 50 real estate developers go into default at the start of this decade. While the nation has adjusted its property policies, construction was a large component of its growth and continues to face major challenges. Asia-Pacific GDP growth is forecasted to be at 3.5% this year, down from last year’s GDP growth of 4.3%. As a result, international REITs and REOCs, particularly in Asia are likely to experience mediocre returns. After the Pacific (at 49.80%), VNQI’s second largest region by holdings weight is in Europe (23.70%). Real GDP growth for Europe is only expected to be 0.6% in 2024. Historically, real estate holdings in Europe have underperformed North American ones as well.
Comparative Real Estate Performance by Geographic Region (Nareit, www.reit.com, 1 Apr 24)
Specifically, in Japan, VNQI’s largest weight by nation, the outlook is also unspectacular. While Japan is seeing some recovery after decades of bleak economic growth, only 1% of GDP growth is expected in 2024 and 2025. Therefore, aside from an incredible turnaround in global economic growth, the international real estate forecast is unimpressive.
Why U.S. REITs May Outperform
The story for U.S. real estate holdings is more upbeat. The Federal Reserve will potentially make interest rate cuts in 2024 and continue making cuts through 2025. This is critical for U.S. REITs. Elevated interest rates increase REIT borrowing costs and make REITs less attractive when fixed income options with high returns come at lower risk. While it is possible that REITs can perform well during times of rising interest rates, this is likely due to the primary factor that those same interest rates are rising because of economic expansion. Therefore, I expect U.S. domestic REITs to do well as the Federal Reserve makes interest rate cuts. The relatively high interest rate bearing safe havens will comparatively look less attractive and reduced interest rates will lower costs for U.S.-based REITs. In contrast to the bleak outlook for international REITs, U.S. REITs may therefore outperform. For consideration, Vanguard Real Estate ETF (VNQ) is the U.S.-based REIT fund equivalent to VNQI.
There Are Better Sectors to Achieve International Diversification
Investors seeking international diversification will likely see better performance through a variety of other sectors. I recently wrote about the Vanguard International High Dividend Yield ETF (VYMI). In this article, I noted the prospects for the fund which includes international holdings in financials, health care, industrials, and other sectors. Of note, this fund has seen a substantially higher historic performance than VNQI. Given the macroeconomic factors of forecast economic growth and interest rates, I expect broader international funds to outperform international REIT funds. Alternatively, investors seeking REIT exposure will likely see better performance with U.S.-based REIT funds.
Current Valuation
VNQI has seen a slightly positive performance over the past year with a 2.46% price return. This recent performance is roughly average compared to peer international REIT ETFs. However, VNQI is currently down 35% since its peak price in January 2018 and down over 30% since its other peak back in April 2013.
One Year Performance: VNQI and Compared Real Estate Funds (Seeking Alpha)
Given the multiple headwind factors impacting the fund, particularly for its Asia-Pacific holdings, I expect the fund to underperform both U.S. REIT ETFs and broad-based international funds not explicitly focused on the real estate sector. Therefore, while VNQI has an attractive valuation as measured by its P/E and P/B ratios, it is not enough of a factor to warrant a buy rating for me.
Valuation Metrics for VNQI and Peer Competitors
|
VNQI |
RWX |
WPS |
IFGL |
|
|
P/E ratio |
13.7 |
16.89 |
11.85 |
11.94 |
|
P/B ratio |
0.8 |
0.92 |
0.87 |
0.87 |
Source: Compiled by Author from Multiple Sources, 2 Apr 24
Risks to Investors
Numerous risk factors for real estate holdings make identifying one leading factor difficult. However, top risk factors include stunted economic growth, inflation, and geopolitics. Inflation and monetary policies also play an important role in the prospects for real estate companies. Based on forecast economic growth for the regions in which VNQI’s top holdings reside, there is a high amount of potential opportunity cost for investing in international real estate funds. While VNQI and peer funds may see greater geographic diversification than U.S. domestic real estate funds, I see greater risk in international REITs.
Concluding Summary
VNQI has several favorable qualities including a low expense ratio, its high amount of diversification in international holdings, and a significant dividend yield. However, there are too many negative factors and risks to warrant a buy rating from me. On a macro level, international real estate holdings in the Asia-Pacific and Europe face minimal GDP growth and geopolitical risks. In contrast to international funds, U.S. REITs face better prospects. Investors seeking international diversification will likely be more pleased with funds that offer multi-sector exposure including health care, industrials, and financials.