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Summary Vanguard REIT Index ETF is positioned to benefit from legislation that may materially improve income and employment prospects for the middle class. The strategy of making employees “exempt” and working them longer hours to generate less than minimum wage is reducing demand for apartments. If income improves for these employees or if more employees are hired it should result in more competition for apartments and higher rents. The rents should increase faster than costs which will drive growth in FFO and earnings. The Vanguard REIT Index ETF (NYSEARCA: VNQ ) is one of the best investment options for investors seeking risk adjusted returns in a tax advantaged portfolio. The ETF offers low expense ratios and excellent diversification of REIT holdings. I believe it is positioned to deliver great returns over the next several years even if we see some increases in interest rates. One of the potential catalysts for it is a bill that would make it more difficult to exploit “salaried” status to force employees to work at or near minimum wage while being classified as a manager. The pending legislation may stir up some fierce political pandering and positioning. Sorry, I believe politicians refer to it as “debate”. The legislation I’m referring to was referenced in a recently released fact sheet . The bill would significantly expand the number of workers eligible for overtime pay. Nearly five million workers would be covered. What Won’t Quite Happen If nothing else changed and the companies simply paid the overtime that is currently avoided through “salaried” compensation, the simple result would be increases in labor expenses and compressed profit margins. At the same time, I would expect increased levels of sales as more money would go to middle class and lower class workers with a high propensity to consume . In short, the money would go into their pockets and then into the cash register at another establishment. If the legislation is passed intact, with no enormous loopholes, the companies impacted by it will surely work to minimize the impact. Despite their best efforts, I believe the companies would still be forced to either pay out higher wages to the impacted employees or reduce their hours to prevent “paid overtime” which is substantially less desirable for the company than “unpaid overtime”. If hours are reduced by hiring more employees because regular hours are less expense than overtime, the result would be lower levels of unemployment. If a thorough cost analysis showed that savings in other areas such as recruitment and intangible benefits made overtime superior to hiring, then the total pay for the impacted employees might increase significantly. The “Middle Class” Perhaps I’m being generous by using the term “middle class” when the bill will help making as little as $24,000 per year that were being classified as “exempt” and worked for upwards of 50 to 60 hours per week. However, the upper end of the protected class is significantly higher at around $50,000 per year. In lower cost of living areas this is solidly middle class in my opinion. Excellent News An increasing level of employment and income among workers in the middle class and below would be extremely favorable for apartment REITs that are already benefiting from solid rental numbers. With the underwriting process on mortgages being fairly strict since the financial crisis there has been a significant increase in the proportion of Americans that have chosen to rent. There is another hidden market though, the boomerang babies. There are many individuals that for lack of income moved back in with their parents after college. Improving employment prospects and higher pay for positions that were previously classified as “exempt” bode well for the average income in the younger generations. Propensity to Consume With low labor costs I expect corporations to spend a significant portion of earnings on repurchasing stock and paying dividends. Dividends are often reinvested and repurchased stock increases the ownership stake for existing shareholders but fails to put any cash in the hand of the shareholders absent a decision to sell some of the shares. Because these uses of cash do not put cash in the hands of consumers that are eager to spend it on immediate consumption, they are not sources of cash that would drive up rent. On the other hand, an increase in income for the middle class and below would drive up demand for independent housing. By independent, I simply mean housing that is not occupied (and owned) by their parents. Great Cost Structure The costs of the equity REITs should not increase as rapidly as the revenue may increase from higher rents. I believe the apartment REITs will see increases in revenue that are mostly carried down to the bottom line increasing EPS and FFO (funds from operations). For shareholders of the equity REITs this is a bullish development because it means the REITs should be paying higher dividends. This argument is bullish for the entire industry and makes a diversified play on the industry like the Vanguard REIT Index ETF an excellent choice. Other Sectors The Vanguard REIT Index ETF holds other kinds of REITs as well. An investor in the fund gains exposure to a diversified REIT portfolio and while I would favor seeing a larger concentration in apartment REITs the other REITs stand to benefit as well. The sector I like less on this news is the personal storage REIT sector where companies may see lower levels of business as consumers are capable of acquiring more housing and reducing their consumption of storage space. On the other hand, there is a legitimate case that many consumers receiving cash will spend it on junk and need a place to store that junk. If consumers do decide to buy more junk that they don’t need it would be a very bullish development for the equity REITs. I’m sure some people will think that I’m being too harsh when I refer to the purchases as “junk they don’t need”, but how often do you really access the items in storage? If they were used on a frequent basis it wouldn’t make much sense to keep them in storage. Growth in junk is a major factor in the demand for storage space. Conclusion I’m personally holding a substantial position in equity REITs which includes a substantial position in VNQ. With prices having fallen over the last few months I have stepped up my purchases in the sector and made it my major investment area for new funds. Despite my strong allocation to the sector, I would love to see prices fall further. Whenever the shares get cheaper the yield gets better and I’m able to buy more for the same price. Who is scared of weakness in share prices? Not me. I’m currently holding between 22% and 23% of my portfolio in domestic equity REIT investments and raising that percentage each month. Disclosure: I am/we are long VNQ. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. Scalper1 News
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