VNQ, SCHH, XLRE ETFs brace for a wall of maturities

Real estate focused ETFs have pulled back this year as investors wait for a wall of maturities in the coming years. The Vanguard Real Estate ETF (VNQ), Schwab US REIT ETF (SCHH), and the SPDR Real Estate Select Sector fund (XLRE) have all pulled back by almost 7% from their highest point this year.

VNQ vs SCHH vs XLRE chart

Federal Reserve rate cuts

The three funds have retreated after the recent US economic numbers from the United States and the ongoing geopolitical risks in the market. Data released this month showed that the labor market was still strong as the economy added over 200k jobs.

A separate report revealed that inflation remained at an elevated level in December. The headline Consumer Price Index (CPI) came in at 3.4% while the core CPI was 3.8%, all higher than the Federal Reserve target of 2.0%.

Therefore, the market expects that the Fed will not cut rates as early as in March as most analysts were expecting. Besides, there are signs that inflation will be sticky for a while as the price of Brent and West Texas Intermediate (WTI) has remained above $70. The World Container Index has jumped from $1,300 in December to $3,777. 

Real estate sector is one of the most sensitive sectors when it comes to interest rates because developers and buyers always rely on loans. This explains why the three ETFs started bouncing back in Q4 as signs of falling inflation emerged. 

The rally intensified in December when the Fed hinted that it would start cutting rates this year. Its accompanying dot plot pointed to three cuts starting in March. Now, the Federal Reserve Rate Monitor Tool places the possibility of a March rate cut at 55%.

Fed rate monitor tool

Wall of maturities ahead

The biggest risk for real estate companies is that many of them are facing a wall of maturities in the coming years. Most of these companies borrowed heavily in the past few years when interest rates remained at zero.

Now, most of these loans have started to come due. In 2023, real estate companies managed to pay over $500 billion in these loans. Many managed to do that by negotiating with the lenders and also through asset sales.

Analysts expect that over $1 trillion of loans are coming due in the next few years, a situation known as a wall of maturities. The challenge is that these maturities are coming at a time when interest rates have surged to a 22-year high. This makes it hard to refinance since their property values have retreated.

The situation is worse in the office industry as many companies start to downsize their office properties. The concept of hybrid working is also increasing and hitting many property companies. As a result, occupancy rates in key American and European cities has dropped sharply.

Therefore, the hope for these ETFs is that the Fed will point to rate cuts soon. However, the concern is that these cuts will not come fast enough. As such, some analysts see trouble in the real estate industry as defaults increase. 

Pressures in the real estate industry could put more pressure on the VNQ, SCHH, and XLRE ETFs, which track the biggest companies in the real estate sector.