What is A Real Estate Investment Trust Exchange Traded Fund (REIT ETF)
Stocks and bonds are financial assets, real estate has always been a real asset. A modern innovation which increased investor access to real estate is through the REIT structure. REITs allow investors to buy into a portion of the real estate and opened up the market for smaller investors.
REIT ETF is a further development which is a portfolio which owns just the listed REITs. The primary benefit of owning a REIT ETF or a portfolio of REITs is it allows investors to diversify the risk of owning a single REIT.
REIT ETF provides a market exposure to the sector and it is one of the easiest and effective means of adding real estate exposure to the portfolio.
The current low interest rate environment provides a favorable backdrop for the performance of REITs but not all REIT ETFs are the same. The difference is attributed to the different composition of the portfolio and we look under the hood to see what make up the top REIT ETFs.
The difference is more acute after Covid-19 which has thrown the sector in turmoil as the pandemic accelerated numerous trends in real estate.
REIT ETF List
Top REIT ETFs
Vanguard REIT ETF (VNQ) is the largest listed US REIT ETF measured by total asset under management. VNQ seek to track the performance of the MSCI US REIT Index which includes the largest REITs listed on the United States.
The weights of the REIT in the index are based on market capitalization adjusted for free float and the availability of stocks for investors. This is the same criteria as the broader MSCI market cap funds. MSCI also regularly reviews the index to ensure companies still meet the criteria to be included in the index inline with ongoing corporate events.
Buying VNG is essentially buying the market and benefit from the long term capital growth and average income yield of all of the listed REITs.
VNG is a typical Vanguard product which they are known for its extraordinarily low management costs. It is one of the top REIT ETF option for passive investors that would like to add real estate exposure to the portfolio.
The management cost is only 0.10% and the ETF is fully transparent in disclosing the underlying investment in the REITs.
Vanguard REIT ETF Performance
The sector breakdown of VNQ shows the benefit of the diversification as no specific REIT sector accounting for more than 30% of the ETF. Similarly the top 10 positions in VNQ accounts for just under 40% of the ETF.
Overall the low cost and broad diversification of VNQ make it one of the best REIT ETF option for long term investors.
SPDR Dow Jones REIT ETF (RWR) tracks Dow Jones U.S. Select REIT Index which is a narrower version of the MSCI US Index with around 90 REITs. It is also a market capitalization weighted index which is adjusted for free float.
On the surface RWR is very similar to VNQ but the breakdown analysis of RWR shows it has additional exposure to real estate sectors outside of the traditional real estate REITs. It has significantly lower commercial real estate exposure to sectors such as office and industrial assets and higher exposure to hotel and other real estate alternatives. Interestingly it has limited exposure to data centre REITs.
Schwab U.S. REIT ETF (SCHH) also tracks Dow Jones US Select REIT Index but as a lower cost version of the above with just under 0.10% management cost.
iShare REIT ETFs
As Vanguard above took the trophy as being the top REIT ETF. iShares has a number REIT ETFs each designed to differentiate from VNQ and aimed at specific sub group of investors with different risk profiles.
iShares Dow Jones US Real Estate Index Fund (IYR) is the second largest REIT ETF from the list above. IYR is designed as a broader REIT market index with over 110 REITs in the fund.
One should note however that total expenses is at around 0.45% vs 0.10% charged by VNQ. Aside from investing in the listed REITs. It is also important to note that 5% of the portfolio include real estate development companies.
Investors that are looking for concentrated bets on REITs can use iShares Cohen & Steers Realty Majors Index Fund (ICF). ETFs traditionally provide a diversified exposure to the sector. ICF only have a select few REITs that are dominant in their respective sector. The goal of designing an ETF that only owns the best in their respective sector follows the idea of buying only the winners and avoid the losers.
Further up the portfolio concentration curve is the iShares Real Estate 50 Index Fund (FTY) which only include 50 of the largest listed REITs.
There are also a rang of sector REIT ETFs. An example of this is iShares Residential Index Fund (REZ). REZ just own REIT stocks with direct residential exposure and is a sector specific REIT which has outperformed the broader REIT market in this Covid environment.
Small Cap REIT ETFs
PowerShares KBW Premium Yield Equity REIT Portfolio (KBWY) is a smart beta ETF. Traditional ETF weights stocks in the fund by market capitalization. Smart Beta ETFs uses factor or specific criteria aside from choosing companies because they are the biggest.
KBWY uses the dividend yield as the main selection criteria for the REITs in the ETF. The yield criteria ensures that the REIT yield target is overall consistent and reflect the investor base being primarily income focused investors.
It should be noted that the REIT it applies the criteria are mostly small and mid cap REITs with total holdings at around 30 to 40 REITs. The number of holdings do provide diversification benefits and dividend yield is at least 100 basis points spread higher than the large cap REIT ETFs listed above.
IQ US Real Estate Small Cap ETF (ROOF) also aim to provide completeness of portfolio REIT coverage by providing exposure to small cap REITs. It has around 60 holdings so theoretically a more diversified fund and dividend yield is on par with KBWY.
Leverage REIT ETFs
Leverage can enhance returns as well as magnify losses. Currently Direxion Daily Real Estate Bull 3x ETF (DRN) and ProShares Ultra Real Estate (URE) provides 3x and 2x Leverage for REIT ETF investors.
For investors taking a leverage position, detail review of the underlying index is important to ensure the leverage ETF provide the required exposure. DRN aim to provide 3x the daily return of the MSCI REIT Index while URE tracks the 2x daily return of the Dow Jones Real Estate Index.
Inverse REIT ETF
Similarly to 3x Leverage REIT ETF DRN. Direxion also has a inverse leverage ETF that tracks 3x the inverse return of the MSCI REIT Index. Bearish investors can use Direxion Daily Real Estate Bear 3x ETF if they have a negative view on the sector to limit risk from shorting individual REIT stocks.