Topping Patterns in Real Estate ETFs Suggest Selling

Buy real estate investment trusts (REITs) when interest rates fall – well that’s the “market wisdom” anyway. REITs are highly sensitive to falling interest rates because their yields start to look relatively more attractive when compared to fixed-income alternatives such as government and corporate bonds.

Investors have indeed bought REITs since the Federal Reserve moved to its more dovish stance regarding monetary policy at the start of 2019. Not only does the sector provide attractive yields, it also provides a level of insulation against collateral damage from trade tariffs imposed by Washington and Beijing in the ongoing trade dispute between the two economic superpowers. These factors help explain why the average large-cap REIT has outperformed the S&P 500 by about 5% so far this year.

Interestingly, as the market prepares for a possible rate cut later this month and the trade war continues to simmer, recent price action in real-estate exchange-traded funds (ETFs) indicates that the next move may be down, not up. Let’s start by looking at one of the sector’s largest funds and then review two ETFs specifically designed to profit from falling REIT prices.

Created 19 years ago, the iShares U.S. Real Estate ETF (IYR) seeks to provide investment results that correspond to the Dow Jones U.S. Real Estate Index. The fund’s benchmark comprises real estate companies listed on U.S. stock exchanges. Key holdings in the ETF’s basket of roughly 115 companies include American Tower Corporation (AMT), Crown Castle International Corp. (CCI), and Prologis, Inc. (PLD). The fund’s daily turnover of more than 6.5 million shares and a razor-thin average spread of just 0.01% keep trading costs low, although those who plan to take a short position must consider the cost of borrowing shares. IYR controls an enormous $4.71 billion asset base, issues a 2.90% dividend yield, and has returned 22.52% year to date (YTD) as of July 12, 2019.

The IYR share price appears to be forming a double top – a pattern that suggests a downside reversal. Although the formation is not confirmed, a bearish divergence between the fund’s price and the relative strength index (RSI) shows fading buyer momentum. Furthermore, a three-bar candlestick pattern known as a bearish abandoned baby makes up the first peak, with a similar pattern also making up the second peak. Traders should anticipate a move down to the $84 level, where the price encounters support from the February swing high and April swing low. Those who execute a short sale can protect trading capital by placing a stop-loss order above the July 10 high at $91.22.

Formed on the eve of the subprime mortgage crisis in 2007, ProShares UltraShort Real Estate (SRS) aims to return two times the inverse daily performance of the Dow Jones U.S. Real Estate Index. The underlying index primarily consists of REITs (91.36%), although it also includes some non-REIT real estate firms. SRS charges a lofty 0.95% management fee, but that shouldn’t bother short-term traders who will appreciate the ETF’s tight 0.07% average spread and ample dollar volume liquidity of more than $1 million most days. As of July 12, 2019, the fund has assets under management (AUM) of $20.58 million, offers a 1.48% dividend yield, and is down 33.23% YTD.

As to be expected, price action on the SRS chart looks almost exactly opposite to that of IYR due to its inverse tactical mission. A possible double bottom, along with a bullish abandoned baby and bullish technical divergence between price and the RSI indicator, point to a reversal back to the upside in subsequent trading sessions. Those who enter at current levels should set a stop slightly under the psychological $20 round number. Consider taking profits at $24, where the price may hit overhead resistance from a horizontal trendline.

With AUM of almost $20 million, the Direxion Daily MSCI Real Estate Bear 3X Shares (DRV) has an objective to provide three times the inverse daily return of the MSCI US REIT Index. The fund uses a mix of swap agreements, futures contracts, and short positions to achieve its leveraged exposure. DRV rebalances daily, which can make long-term returns unpredictable due to the effects of compounding. Leading sector weightings include specialized REITs at 18.70%, retail REITs at 18.06%, and residential REITs at 17.67%. Traders should consider using limit orders given the ETF’s sometimes wide bid/ask spread and modest share volume liquidity. As of July 12, 2019, DRV has tumbled nearly 40% YTD and sits just 4.3% above its 52-week low of $29.24 set on July 10. Investors receive a 1.24% dividend yield.

Yesterday’s price reversal back above the June swing low increases the chance that the most recent trough on the chart may carve out a double bottom pattern. Like SRS, a bullish divergence exists, indicating that the bears have lost their mojo. An RSI reading below 50 gives the fund’s price plenty of room to run higher and test crucial resistance at $37.50. Manage downside risk by taking a small loss if the price can’t hold above its 52-week low. Traders may decide to raise stop orders to the breakeven point if the price moves above the 50-day simple moving average.