Real Estate Sector Trading Strategy (Backtests And Examples)
Last Updated on October 14, 2022
The real estate industry group, previously stuffed inside the Financials sector, was elevated to a market sector level in 2016, making it the 11th sector in the S&P 500 index. Let’s take a look at the newest addition to the S&P sectors to see what it offers.
In this article, we describe the real estate sector and we end the article by backtesting a real estate trading strategy. Actually, we do several backtests and even offer a real estate seasonality. The real estate sector behaves slightly differently than the overall stock market, and thus might offer some diversification benefits for short-term traders.
What is the S&P Real Estate sector?
This sector consists of companies that are involved in real estate, including realtors, companies that develop and manage real estate projects, and real estate investment trusts (REITs) — which are special tax-favored business entities that own, operate, or finance income-generating real estate. However, not all REITs are part of the real estate sector; mortgage REITs are still in the Financial sector.
The S&P 500 real estate sector currently consists currently of 31 stocks, but the number of stocks varies over time. The sector makes up about 2.9% of the index.
Companies you will find in the sector include the cellular communications tower specialist American Tower Corp., major shopping mall owner, and operator Simon Property Group, Boston Properties, and Equinix.
Two popular ETFs that track the sector are Real Estate Select Sector SPDR Fund (XLRE) and Vanguard Real Estate ETF (VNQ). However, there are many other smaller ETFs.
What are the 5 biggest stocks in the sector?
The top stocks by market cap include (but by the time you read this it might be different top 5 stocks):
- American Tower Corporation (AMT): One of the largest global REITs, it owns, develops, and operates multitenant communications real estate. It has a portfolio of approximately 219,000 communications sites. Its current market cap as of July 2022 is $119.501 billion, and the stock has been doing well in recent years.
- Prologis, Inc. (PLD): This is the global leader in logistics real estate with a focus on high-barrier, high-growth markets. The company leases modern logistics facilities to a diverse base of customers principally across two major categories: business-to-business and retail/online fulfillment. The stock has been doing well in recent weeks, with its current market cap as of July 2022 being $92.624 billion.
- Crown Castle International Corp. (CCI): The company owns, operates, and leases more than 40,000 cell towers and approximately 80,000 route miles of fiber supporting small cells and fiber solutions across every major U.S. market. Its nationwide portfolio of communications infrastructure connects cities and communities to essential data, technology, and wireless service. It has a market cap of $75.144 billion as of July 2022.
- Equinix, Inc. (EQIX): This is a digital infrastructure company that enables digital leaders to harness a trusted platform to bring together and interconnect the foundational infrastructure that powers their success. It helps businesses to scale with agility, speed the launch of digital services, deliver world-class experiences and multiply their value. Its current market cap as of July 2022 is $58.015 billion, and the stock has been doing well in recent weeks.
- Public Storage (PSA): This is a REIT that primarily acquires, develops, owns, and operates self-storage facilities. It invests in self-storage facilities in the US and Europe, including some common equity interests in Shurgard Self Storage SA and PS Business Parks. The stock has been performing fairly well in recent weeks, and as of July 2022, its market cap is $55.67 billion.
The 5 companies above illustrate that the real estate sector is a pretty diverse sector with a lot of different business models.
That said, let’s go on to backtest a few real estate trading strategies:
Real estate trading strategy 1 (VNQ trading strategy)
Let’s go on to backtest our first real estate trading strategy (we use VNQ). We start with a seasonal strategy. As with most of the other sectors in the stock market, real estate also has months that are better than others.
It turns out that the real estate sector has had a strong tailwind from early March until late July. Let’s backtest VNQ and buy the open in March and sell the open in August. We get the following equity curve:
The annual gain is 6.43% which is much better than buy and hold of 3.7%. Please keep in mind that the backtest doesn’t include reinvested dividends which might make the difference slightly smaller.
If we look at each separate month we get the following table returns per month:
The first column indicates the month and the third column the average gain per month in percent.
Real estate trading strategy 2 (VNQ trading strategy)
Let’s go on to backtest another real estate strategy for stocks. We get the following equity curve:
The equity curve of the above strategy is based on two parameters and one parameter for the exit. The average gain is 0.74% per trade, the win rate is 80%, max drawdown is a modest 11%, and the profit factor is a respectable 2.7.
We are not revealing the strategy because we plan including it in our monthly trading edges.
Backtesting real estate sector strategies in the stock market
Real estate stocks are a bit different than “ordinary stocks”.
For example, Amazon is dependent much more on management and skills, while real estate stocks to a much bigger extent are exposed to outside factors management can’t control. We believe many real estate investors disagree, but this is our opinion.
An example is interest levels which are of much more importance for almost all real estate companies – much more so than for Amazon.
Thus, we believe backtesting is of less value compared to many other sectors of the market. When a sector or asset is dependent on macro factors it gets a lot more difficult to find long lasting trading strategies. Macro is extremely difficult to forecast, we would say impossible to forecast, and thus the strategies are dependent on future random events.
Because of this, the real estate sector might offer some diversification benefits for traders when you are making new trading strategies. The importance of diversification and lack of correlation is something we have covered in many previous articles:
- What does correlation mean in trading? (Trading strategies and correlations)
- Uncorrelated assets and strategies – benefits and advantages (examples and backtests)
- Does your trading strategy complement your portfolio of strategies?
- Why build a portfolio of quantified strategies (including two strategies)
Other sector trading strategies
We have covered all the different subsectors in the S&P 500:
- Sector trading strategy
- Industrials Sector Trading Strategy
- Consumer Discretionary Sector Trading Strategy
- Financial Services Sector Trading Strategy
- Technology Sector Trading Strategy
- Materials Sector Trading Strategy
- Healthcare Sector Trading Strategy
- Energy Sector Trading Strategy
- Communication Services Sector Trading Strategy
- Biotech trading strategy
- Homebuilder trading strategy
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Real estate trading strategy – ending remarks
The real estate sector might offer some diversification benefits for traders. This means that even strategies that might not be optimal on their own still can be very useful in a portfolio of strategies. Many traders overlook this aspect, unfortunately. Most likely, the real estate trading strategy we made in this article could be very useful for the majority of traders.