Real Estate ETF Funds vs. Case Shiller Housing Index

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So what if you want to invest in the Case Shiller?

Which real estate (REIT) ETF's best follow the Case Shiller Housing Index? If you look at the plot below (with a log scale of course) you will see a time series plot back to 2000 showing:

• The Case Shiller 10 City Index
• The SPY ETF which follows the S&P500 stock index.
• 5 of the most popular real estate ETF's : IYR, ICF, VNQ, RWR, and RWX.

Looking at the above plot you may notice a few things.

1. The real estate ETF's follow each other very closely.
2. The real estate ETF's seem to follow many of the gyrations of the S&P500 (SPY) especially including the market tanking last year.
3. The Case Shiller may sorta follow some of the movements of the real estate ETF's but only in general, not very well short term for sure.

Examining the Cross Correlations

I introduced the principal component analysis loading plot in this post recently. This is a very cool and caveman-intuitive graph for examining the cross correlations of a group of many variables.



What you see in the loading plot above more clearly shows how the real estate ETF's are all very correlated to each other. Might as well flip a coin here, they all basically are following nearly the same path. Then, the real estate ETF's are closely correlated to the S&P500. This is a big problem if one is investing in a real estate ETF for the purpose of diversification. I find this to be a common problem. People think they are diversified because they might be in different "sectors" or stocks, but the fact is, nearly all equities in companies will follow very closely to each other and the general market.

Unfortunately, the thing that is least correlated to the real estate ETF's is the Case Shiller index! So if you thought you would invest in some real estate ETF's to take advantage of a housing market expectation, you were mistaken.

The actual correlation coefficients agree with all of this. The real estate ETF's have correlation coefficients of 0.90's and above. The SPY (S&P 500) has correlation coefficients of 0.60 to 0.80 to all the real estate ETF's. The Case Shiller has weak correlation coefficients of 0.30's with the real estate ETF's.

Bottom Line: if you want to invest in the Case Shiller you really can't except by buying a house. But that is all about to change with the introduction of the MacroMarkets Major Market Housing ETF's UMM and DMM (which are 3x and inverse 3x leveraged to the Case Shiller) opening for trade next week. More on those in coming posts this week.

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