New Property Fund Meets Distressed Market

Invesco PowerShares plans to launch the first actively managed U.S. real estate ETF this week.

The PowerShares Active U.S. Real Estate Fund, which will begin trading on the New York Stock Exchange under the ticker PSR, will invest in real estate securities included in the FTSE NAREIT Equity REITs Index.

The Equity REITs Index has fallen 41.2% this year, more than the S&P 500's 37.6% decline. PowerShares views this drop as an opportune entry point, but the firm will need to persuade investors that this is the bottom.

"The biggest challenge is certainly the current market environment, which has so many investors fearful and sitting on the sidelines," said Ed McRedmond, senior vice president of portfolio strategies for Invesco PowerShares.

The new fund will be managed by Invesco Institutional, which has managed real estate securities since 1988. The team comprises 13 investment professionals who had about $8 billion in assets under management as of Sept. 30.

McRedmond said PSR's lead manager, Joe Rodriguez, and his team "are arguably among the top REIT investment managers in the country."

PSR will have to outperform the iShares Dow Jones U.S. Real Estate Fund ( IYR) and the SPDR Dow Jones Wilshire REIT ETF ( RWR). IYR and RWR are passively managed ETFs, whose top holdings include Simon Property ( SPG), SL Green Realty ( SLG), Vornado Realty Trust ( VNO), ProLogis Trust ( PLD) and Boston Properties ( BXP). The funds have been thrown for 42.2% and 40.76% losses so far this year.

A commercial focus

PSR initially will take a more focused approach.

"The objective is to create value above that of a passive index," said Rodriguez. "At the onset, we expect to hold between 45 and 55 positions."

IYR and RWR, in contrast, have about 80 holdings each.

One advantage of an actively managed approach is the Invesco team will be able to avoid areas of the market that have been among the hardest hit from the credit crunch. "PSR is focused on commercial real estate and not single-family housing," said Rodriguez. "While tenant demand may be lagging, commercial property markets are entering this slowdown with relatively contained levels of new construction. Unlike previous commercial property cycles, we are not seeing massive overbuilding."

Rodriguez acknowledges that commercial REITs may be facing a tough environment, but he believes that many will pull through. "In this environment, vacancy rates are likely to increase over the next two years," he said. "Our expectation is that for better managed companies and better positioned portfolios, these increases in vacancy should be manageable."

Making the cut

Because PSR will be actively managed, it probably will have a higher turnover rate than the 5% to 15% of IYR or RWR. "It wouldn't be impossible for the fund to experience annualized turnover rates in the 50% to 125% range," said Rodriguez. "Keep in mind that the ETF structure should allow most of this turnover to occur through in-kinding of securities, which shouldn't generate a taxable event."

IYR and RWR have dividend yields of close to 7%, which may not be sustainable, given falling revenue and profits.

"Any potential dividend cuts are likely to be manageable," said Rodriguez. "Dividend yields for U.S. REITs average 7.5%. Those yields coupled with share prices implying value of the underlying commercial properties below replacement cost give us several positive reasons to launch PSR at this time."

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