VRE (VNFTF): Downside Risk Remains

ETF Overview

Vanguard FTSE Canadian Capped REIT Index ETF (TSX:VRE:CA) invests in Canadian REIT and actual property shares. VRE has a excessive publicity to financial delicate sectors and is sadly not immune in an financial recession. Shares in VRE’s portfolio will proceed to face difficult macroeconomic situations in 2023 akin to elevated charges and a weakening economic system. Subsequently, buyers could need to look forward to extra readability earlier than leaping in to take a position.

Fund Evaluation

VRE had a poor 2022 however has since rebounded

Just like the broader fairness market, VRE delivered a 12 months of adverse returns in 2022. Throughout all the 12 months, its fund worth has suffered a decline of practically 29%. This decline is far more than the lack of 11% of the S&P/TSX Composite Index. The decline was primarily as a result of sky-rocketed inflation and Financial institution of Canada’s aggressive charge hikes to tame inflation. Nevertheless, inventory market had a year-end rally because of the market’s optimism about inflation. VRE additionally noticed a rebound of its fund worth because the fund climbed up 16.9% throughout this rebound.

Regardless of its engaging distributions, VRE is just not defensive

Whereas many buyers actually like REITs as they supply engaging distributions typically north of 4% in Canada, this isn’t with out dangers. REITs are usually not defensive in nature. In different phrases, REITs are charge delicate shares that may be impacted negatively in an financial downturn. That is true additionally for VRE as an awesome majority of its portfolio consists of REITs.

In contrast to its Canadian peer iShares S&P/TSX Capped REIT Index ETF (XRE:CA) which owns solely REITs, VRE additionally consists of some actual property companies and growth shares. On condition that actual property companies and growth shares are usually extra delicate to the adjustments of economic system, it’s way more cyclical than REITs which derive most of their revenues from rental incomes. Within the chart, we confirmed 3 actual property companies or growth shares, Tricon Residential (TCN:CA), Colliers Worldwide (CIGI:CA), and FirstService (FSV:CA) in VRE’s portfolio. As could be seen, these three shares are inclined to fall way more sharply than VRE throughout market turmoil akin to in 2020. Additionally they are inclined to underperform in a charge improve cycle atmosphere akin to in late 2018 or final 12 months.

Moreover these two actual property subsectors which might be delicate to charge adjustments, VRE’s portfolio additionally consists of REIT subsectors which might be delicate to financial situations and charges. These sectors embrace retail, industrial, and workplace REITs. They encompass 52.8% of the overall portfolio. Along with actual property subsectors, these economically delicate sectors make up practically 77% of the overall portfolio.

Is that this the fitting time to take a position now?

On condition that VRE’s fund worth has already rebounded by practically 17% since reaching the low in late October 2022, there is probably not extra upside within the near-term. Because the economic system can also be fairly unsure in 2023, we aren’t able to make the decision to purchase VRE. Listed below are our causes: First, we’re seeing indicators of a weakening job market. Whereas unemployment charge remained very low in Canada, the overall hours labored decreased in December. This seems to be an early sign of demand softening. It’s because companies normally reduce hours labored first earlier than chopping jobs. The aggressive charge hikes we’ve seen final 12 months will finally ripple by the economic system and impression shopper spending and enterprise spendings. Demand for retail, industrial, or workplace areas will possible diminish because the 12 months unfolds.

Second, inflation seems to be an ongoing drawback regardless that it has peaked in mid-2022. To fight inflation, Financial institution of Canada can have no selection however to maintain the speed elevated for a prolonged interval. The impression may also be adverse as borrowing prices will stay excessive. Since REITs are sometimes leveraged, these corporations can have no selection however to resume their mortgages with larger rates of interest upon maturities of their loans.

Third, in addition to the impacts that the elevated rate of interest can have on REITs, elevated charge may also impression the broad economic system and should tip the nation in the direction of a recession. Previously 2 recessions, REITs have carried out poorly. As could be seen from the chart under, VRE noticed practically 50% decline within the final recession brought on by the pandemic. Though we don’t have information of VRE previous to its inception in 2012, its peer XRE noticed a decline over 60% within the Nice Recession in 2008/2009. Subsequently, buyers ought to train warning and be ready that there could also be extra draw back dangers particularly if conditions worsen.

Investor Takeaway

Though VRE has rebounded from a low reached in late October 2022, we predict there’s nonetheless extra ache forward. The danger stays excessive as we could also be heading for a recession and REITs akin to VRE are inclined to carry out poorly in an financial recession. Subsequently, we imagine buyers ought to wait patiently and keep on the sideline.

Extra Disclosure: This isn’t monetary recommendation and that every one monetary investments carry dangers. Buyers are anticipated to hunt monetary recommendation from professionals earlier than making any funding.