REIT ETFs: Risk-Adjusted Performance Assessment

REIT ETFs faced significant headwinds in 2025, yet two funds stood out as relative winners in November: REZ and REM, according to a recent analysis. Their appeal lies partly in low fees, . These funds offer diversified exposure across real estate sectors, including residential, industrial, and healthcare properties, which helps mitigate single-stock risk.

This relative outperformance is notable against the backdrop of broader market volatility, where REIT ETFs delivered mixed performance YTD amid challenging conditions. They contrast sharply with the Vanguard Global ex-US REIT ETF (VNQI), .

Historically, have been a significant tailwind for REITs. When rates fall, borrowing costs decrease and property valuations tend to rise, with REITs often outperforming the broader US stock market. Post-Fed easing cycles have seen REITs deliver an annualized return of 9.48% compared to 7.57% for the wider market. Sectors requiring substantial , like , , and healthcare facilities, typically show the strongest reactions to rate cuts.

However, this yield-driven appeal faces significant friction. Not all REIT sectors benefit equally from rate reductions; lodging and retail/mall REITs tend to react less favorably. Furthermore, their performance remains highly sensitive to interest rate expectations and broader economic cycles. The sustainability of their dividends and valuations could come under pressure if rate cuts are delayed or economic growth weakens. For income-focused investors navigating this environment, the sector divergence and interest rate sensitivity represent crucial risks alongside the relative outperformance of funds like REZ and REM.

Dividend Sustainability Under Pressure

REITs must distribute roughly 90% of their taxable income to shareholders as dividends to maintain their special tax status, creating inherent pressure on their payout capacity. This high distribution requirement means less retained earnings available for reinvestment or building cash buffers, especially vulnerable when income streams weaken. , signaling investor concern about their ability to sustain distributions amid volatility. , their structures don't inherently solve the underlying income volatility challenges facing many REITs this year.

The proposed repeal of specific introduces regulatory uncertainty that could materially impact foreign investor participation and tax treatment. The Treasury's October 2025 proposal eliminates the "look-through" requirement for domestic C-corp shareholders, simplifying compliance by treating all domestic C corps as U.S. persons. This reversal of the 2024 rule aims to reduce complexity and lower tax exposure for foreign investors holding REIT shares through corporate structures. However, the change remains a proposal until final rules are issued, creating ambiguity for international holders during the transition period. The outcome could reshape foreign investment flows into U.S. REITs, affecting demand and pricing dynamics before the dust settles.

SCHH's passive approach contrasts with actively managed strategies but doesn't fully insulate it from sector-wide distribution risks. While its low expense ratio helps preserve yield, the ETF's holdings remain subject to the same underlying income pressures affecting individual REITs. The proposed regulatory shift adds another layer of unpredictability, particularly for foreign-owned assets within the portfolio. Investors should monitor whether the final FIRPA rules accelerate or delay foreign capital's response, as reduced institutional demand could pressure REIT share prices and ultimately dividend sustainability across the sector during this regulatory limbo.

Rate Sensitivity Mechanics and Sector Divergence

Lower interest rates historically boost REIT valuations, . This outperformance stems from reduced borrowing costs and heightened yield appeal for income investors. However, not all real estate sectors react equally to rate shifts. , , and -often capital-intensive-tend to surge more sharply when rates fall, while show a weaker response, reflecting their sensitivity to broader economic cycles and discretionary spending. For investors, this divergence creates opportunities but demands sector-specific scrutiny.

U.S. REIT ETFs illustrate these dynamics. DFA Real Estate Securities (DFREX) exemplifies long-term success, . Schwab's broader SCHH ETF, after expanding its index in 2020, outperformed peers but still trailed DFREX by about 10% in early 2020. Global funds, like VNQI, , highlighting the cost drag in a challenging environment. Their higher expense ratios compared to domestic funds further eroded gains.

amplify these risks. The repeal of the has significant implications, but ongoing policy uncertainty could disrupt income streams for income-focused portfolios. While rate cuts may temporarily lift REIT valuations, investors should weigh this against sector weaknesses-especially lodging and malls-where economic downturns could quickly negate any monetary easing benefits. Diversification alone won't shield against these headwinds; sector selection and regulatory exposure now matter more than ever.

Risk-Driven Positioning Strategy

The current risk environment calls for trimming exposure to like VNQI and RWO. These funds have lagged dramatically over the long term due to weak overseas real estate markets, , far below U.S.-focused alternatives. This underperformance stems from global diversification's drag during periods of international real estate weakness.

Sector volatility remains a critical concern. -which carry higher sensitivity to economic cycles-exhibit amplified price swings during interest rate shifts, creating liquidity risks during market stress. While sectors like benefit from capital-intensive models during rate cuts, they don't offset the broader instability in discretionary property segments.

The divergence between U.S. and global REIT ETFs underscores this strategy. DFA Real Estate Securities (DFREX) tripled a $10,000 investment over 14 years by concentrating on high-growth U.S. assets like telecom towers, while Schwab U.S. REIT ETF (SCHH) outperformed peers after expanding its index coverage in 2020. Both funds benefited from domestic exposure, contrasting sharply with VNQI and RWO's global underperformance.

No action is warranted if dividend coverage weakens without concrete evidence. The current adjustment targets structural outperformance gaps rather than temporary yield fluctuations. Maintaining this stance aligns with the "Visibility Decline = Reduce Position" rule amid elevated sector volatility.