The Vanguard REIT Index Fund (VGSIX) Did Its Job, Despite The Crash

It’s no secret the recent bear market was brought on by the bursting of the massive residential real estate bubble.  While commercial real estate is a bit of a different animal than residential real estate, commercial real estate is, as a general rule, quite sensitive to macroeconomic conditions.  The reason is obvious:  when times are tough, there’s less demand for commercial property (retail space, industrial space, etc).  With the possible exception of storage properties (people have to store their excess crap somewhere after being forced to down-size), commercial real estate promptly dropped like a rock off its 2006 highs.

The Vanguard REIT Index Fund

Perhaps the best way to invest in the commercial real estate market is via Real Estate Investment Trusts, or REITS.  Investors in the Vanguard REIT Index Fund (VGSIX) have lost an average of 13.69% per year over the three year period ending 2/28/2010.  Despite the fact that the REIT index fund has almost doubled over the last year, things haven’t been pretty for REIT investors for quite some time, with the average REIT fund still well off its 2008 highs.

A Longer-Term Perspective

Looking at the fund’s recent performance, one might understandably be a bit wary of investing in this asset class.  Still, real estate has proven to be an effective diversified in the past and has a solid long-term track record.  The Vanguard REIT index fund, which tracks a modified version of the MSCI US REIT Index, has almost 14 years of history now.  Introduced on May 13, 1996, the fund has averaged 9.13% per year for the period ending 2/28/2010, a period that included one of the worst bear markets for real estate on record.  Furthermore, the fund has consistently been a decent (although not great) diversifier for a portfolio of U.S. stocks, with a correlation coefficient of between 0.5 and 0.8% with the Vanguard Total Stock Market Index Fund (VTSMX) for the vast majority of the period.

Almost as importantly, the REIT index fund has adequately met one of the primary objectives of almost any real-estate focused mutual fund:  providing a steadily growing stream of income for investors.  While its current yield of 4.31% is less than the asset class;s historical yield, it is still well more than double the yield of the total stock market.  And as rents steadily climb as the economy slowly recovers, I believe REIT yields will someday regain a measure of their old luster.

So while it’s true the past few years haven’t been kind to REIT mutual fund investors, the fundamentals of the asset class remain strong and what’s more, the long-term performance of real estate is still quite good even accounting for the recent bust!  That is to say, it’s probably as good a time as any to buy a REIT fund provided you’re in it for the long term.