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 (NYSEArca: VNQ) has a three year annualized return of 16.1%, outperforming the 11.4% gain posted by the S&P 500. [Best REIT and Real Estate ETFs for Yield]
“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 (NYSEArca: RWR).
“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.”
Next page: REIT fundamentals
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 REITs-related ETFs.
The Vanguard REIT ETF tracks the MSCI US REIT Index, which includes a broad range of REITs companies, except mortgage REITs. VNQ has a 3.37% 12-month yield and a 0.10% expense ratio.
The fund has 121 holdings and the top ten make up 42.3% of the overall portfolio. Top holdings include Simon Property 10.7%, Public Storage 4.7%, HCP 4.6%, Ventas 4.3% and Equity Residential 4.1%.
Sub-sector allocations include diversified REITs 7.4%, industrial REITs 5.0%, Office REITs 13.8%, Residential REITs 16.2%, Retail REITs 26.7% and Specialized REITs 30.8%.
The iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) tries to reflect the performance of the Dow Jones U.S. 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 ETF has 95 holdings and the top ten make up 39.2% of the overall portfolio. Top holdings include Simon Property 8.6%, American Tower 5.1%, HCP 3.8%, Ventas 3.7% and Public Storage 3.7%.
Sub-sector allocations include specialty REITs 29.7%, retail REITs 20.5%, industrial REITs 18.0%, residential REITs 12.2%, mortgage REITs 8.7%, hotel & lodging REITs 4.5%, real estate services 2.7%, real estate holdings 1.9% and diversified REITs 1.4%.
Next page: More top REIT ETFs
The iShares Cohen & Steers Realty Majors Index Fund (NYSEArca: 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 fund has 31 holdings and the top ten make up 61.6% of the overall portfolio. Top components include Simon Property 7.8%, HCP 7.4%, Ventas 7.3%, Public Storage 7.1% and Prologis 6.0%.
The ETF has roughly equivalent weightings in office, residential, healthcare and retail REITs.
The SPDR Dow Jones REIT ETF tries to reflect the performance of the Doe Jones U.S. Select REIT Index, which follows companies that operate commercial REITs and excludes mortgage REITs. RWR has a 2.7% dividend yield and a 0.25% expense ratio.
The fund has 85 holdings and the top ten make up 48.8% of the overall portfolio. Top holdings include Simon Property 11.8%, HCP 5.1%, Ventas 4.95%, Public Storage 4.9% and Prologis 4.1%.
Sub-sector allocations include regional malls 18.5%, healthcare 16.3%, apartments 15.0%, office 11.2%, strip centers 7.7%, industrials 7.7%, self-storage 6.7%, hotels 5.9%, diversified 4.2%, mixed industrial/office 4.1%, manufactured homes 1.0% and factory outlets 0.8%.
The Schwab U.S. REIT ETF (NYSEArca: SCHH) tries to reflect the performance of the Dow Jones U.S. Select REIT Index. SCHH has a 2.31% distribution yield and a 0.07% expense ratio.
The fund has 86 holdings and the top ten make up 49.0% of the overall portfolio. Top holdings include Simon Property 11.8%, HSCP 5.1%, Ventas 5.0%, Public Storage 4.9% and Prologis 4.1%.
Sub-sector allocations include specialized REITs 28.9%, retail REITs 26.9%, Residential REITs 17.5%, Office REITs 14.9%, Diversified REITs 6.5% and industrial REITs 5.3%.
The First Trust S&P REIT Index Fund (NYSEArca: 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 0.50% expense ratio.
The ETF has 129 holdings and the top ten make up 42.9% of the overall portfolio. The top holdings include Simon Property 10.4%, HCP 4.5%, Ventas 4.4%, Public Storage 4.3% and Prologis 3.6%.
Sub-sector allocations include diversified REITs 8.2%, industrial REITs 4.0%, office REITs 13.7%, residential REITs 15.6%, retail REITs 27.0% and specialized REITs 30.4%.
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.