Relief in the form of this year’s 12% decline in 10-year Treasury has lifted real estate investment trusts (REITs) and the corresponding exchange traded funds.
A predictable beneficiary of that trend has been the Vanguard REIT ETF (NYSEArca: VNQ), the largest U.S. REIT ETF. Signs of a recovering U.S. economy and falling interest rates have been stoking investor interest in REIT ETFs. Only three ETFs have taken in more new assets this than the marketweight-rated VNQ. The ETF is up nearly 15% year-to-date. [Tactical Risk Management With ETFs]
Rapidly approaching $24 billion in assets under management, VNQ is not just the largest REIT, but the eleventh-largest U.S. ETF overall. As is the case with many Vanguard ETFs, VNQ has gained denizens of loyal followers due to an expansive lineup and low fees.
Fees are crucial in the evaluation of REIT ETFs because VNQ and its primary competitors usually feature top-10 lineups that mirror each other. VNQ charges just 0.1% per year, making it less expensive than 92% of rival funds, according to Vanguard.
Only the Schwab US REIT ETF (NYSEArca: SCHH) at 0.07% bests VNQ in terms of annual fees.
“Because most REIT ETFs have very similar holdings, expense ratios are a particularly important consideration when choosing a fund tracking the sector,” notes Morningstar analyst Abby Woodham. “It has also tracked its benchmark very closely: VNQ’s estimated holding cost, which is a Morningstar data point that measures the difference in performance between a fund and its benchmark, is 0.03%. When a fund’s estimated holding cost is very close to its expense ratio, it helps show that the fund is tracking well.”
VNQ’s top-10 holdings, which combined for nearly 39% of the ETF’s weight at the end of May, include Simon Property (NYSE: SPG), Public Storage (NYSE: PSA) and Equity Residential (NYSE: EQR). However, as Morningstar notes, about a third of the ETF’s nearly 140 holdings dwell in small-cap territory.
That has been advantage this year as small-cap REITs have proven stronger than the broader universe of small stocks. For example, the IndexIQ US Real Estate Small Cap ETF (NYSEArca: ROOF), a dedicated small-cap REIT ETFF, is up nearly 10% this year compared to a 2.5% gain for the iShares Russell 2000 ETF (NYSEArca: IWM). [A Big REIT Yields in This ETF]
Interest rates remain the primary concern for VNQ and rival REIT ETFs going forward. Last year, the ETF managed a 2.1% gain as the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) tumbled 6.1%.
“Because REITs must pay out most of their income as dividends, they rely on debt for growth. For REITs, higher rates mean more-expensive debt servicing and less business reinvestment. REIT yields also become less attractive relative to Treasuries when rates are high, putting downward pressure on the sector’s valuation,” according to Morningstar.
Vanguard REIT ETF
ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of IWM.