1 Reason to Buy the Vanguard Real Estate ETF (VNQ)

Key Points

• The Vanguard Real Estate ETF could be a big winner as interest rates fall.
• Real estate investment trusts (REITs) are rate-sensitive, and for a few reasons.
• REITs have a strong history of outperforming in falling-rate environments.
• 10 stocks we like better than Vanguard Real Estate ETF ›

The real estate sector has underperformed the S&P 500 (SNPINDEX: ^GSPC) significantly over the past decade. The Vanguard Real Estate ETF (NYSEMKT: VNQ) delivered a 77% total return for investors over the past decade, compared with a stellar 290% return from the Vanguard S&P 500 ETF (NYSEMKT: VOO).

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Learn More Powered by Money.com - Yahoo may earn commission from the links above. It isn't necessarily that real estate investment trusts, or REITs, are doing poorly as businesses. They aren't. Rather, the underperformance can be blamed on two factors.

First is that fact that the S&P 500 -- and especially the megacap technology stocks -- has done incredibly well. And the second reason is interest rates.

Image source: Getty Images. ## Why interest rates can hurt REIT stock performance

REITs are some of the most rate-sensitive stocks in the entire market, and for a few reasons:

• REITs depend on borrowed money for growth, and higher rates makes borrowing less attractive.
• Commercial real estate values are based on expected rental income potential, adjusted for risk-free rates. In other words, rising rates can push commercial property values lower.
• Higher interest rates can cause an investor rotation out of riskier investments like REITs and into CDs, Treasury securities, and others.

The biggest reason to buy now?

The Federal Reserve is widely expected to gradually lower rates, and chairman Jerome Powell's recent Jackson Hole speech cleared the way for this to start in September.

In the previous section, I mentioned three reasons why rising rates are bad for REITs. Well, they all work the other way too. If rates start to fall, it could create a better growth environment for REITs, cause investors to rotate money into the sector, and generally be an upward catalyst.

Should you buy stock in Vanguard Real Estate ETF right now?

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Matt Frankel has positions in Vanguard Real Estate ETF and Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Vanguard Real Estate ETF and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.

1 Reason to Buy the Vanguard Real Estate ETF (VNQ) was originally published by The Motley Fool

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