Several REIT-based ETFs offer excellent entrées into the housing market, without risking a huge amount of capital, says Tom Lydon of ETF Trends.
Exchange traded funds tracking commercial real estate have outpaced the S&P 500 the past few years, and more investors are gravitating to REIT ETFs for yield since interest rates are so low.
Vanguard REIT ETF (VNQ) has a three-year annualized return of 16.1%, outperforming the 11.4% gain posted by the S&P 500. This REIT ETF tracks the MSCI US REIT Index, which includes a broad range of REITs, but not mortgage REITs. VNQ has a 3.37% 12-month yield and a 0.1% expense ratio.
“REITs have historically earned returns between bonds and stocks due to their stable income streams and potential for capital appreciation,” said Daniel Farley, a senior managing director at State Street Global Advisors. “In the shorter term, our expected return models suggest that REITs have begun to look mildly expensive, but the appeal of their income features seems likely to foster continued support for the asset class in the current low interest environment.”
State Street manages SPDR Dow Jones REIT ETF (RWR). This REIT ETF tries to reflect the performance of the Dow Jones US Select REIT Index, which follows companies that operate commercial REITs, and also excludes mortgage REITs. RWR has a 2.7% dividend yield and a 0.25% expense ratio.
“Equity REITs are a hybrid asset class, offering yield and the possibility of capital appreciation,” according to Morningstar analyst Abby Woodham. “These firms generate income by managing properties and collecting rent. They are required to distribute at least 90% of their taxable income to shareholders, which is the source of their desirable yield.
"In the past, REITs were viewed as a liquid way to buy commercial real estate and improve a portfolio’s diversification. Real estate also has some inflation-hedging qualities.”
Currently, the recovering economy is supporting the REIT sector. The residential real estate market has turned around, and commercial real estate prices are also rising. As the economy produces more jobs, we are seeing rising rents and improving occupancy levels.
“Since 2007, REITs have taken advantage of low interest rates and refinanced their debts,” Woodham added. “Many have rock-solid balance sheets and improving cash flow.”
However, a rising interest rate environment could weigh on REIT investments, especially companies that have not refinanced to take advantage of low rates.
Potential investors should know that REIT dividends are mostly taxed as income. Firms will pass on the majority of earnings, along with the tax liability, to shareholders.
There are a number of REIT-related ETFs. One, the iShares Dow Jones US Real Estate Index Fund (IYR) tries to reflect the performance of the Dow Jones US Real Estate Index, which includes real estate companies and REITs. IYR has a 3.52% 12-month yield and a 0.46% expense ratio.
The iShares Cohen & Steers Realty Majors Index Fund (ICF) tries to reflect the performance of the Cohen & Steers Realty Majors Index, which consists of the largest and most traded REITs diversified across different property sectors. ICF has a 2.86% 30-day SEC yield and a 0.35% expense ratio.
The Schwab US REIT ETF (SCHH) tries to reflect the performance of the Dow Jones US Select REIT Index. SCHH has a 2.31% distribution yield and a 0.07% expense ratio.
The First Trust S&P REIT Index Fund (FRI) tries to reflect the performance of the S&P United States REIT Index, which tracks a cap-weighted basket of REITs, excluding large mortgage REITs. FRI has a 2.31% 12-month yield and a 0.5% expense ratio.