REIT ETFs: A Comprehensive Guide

REIT Industry Outlook

The U.S. REIT industry has been on a roller coaster so far this year. After a remarkable run in the first four months, the sector nosedived in May, as rising interest rates and skepticism about the Fed’s QE program spread caution in the market. The apprehensions spilled over to August.

But around mid-September, the REIT stage was again set for action with the Fed’s ‘no taper’ decision and lower GDP projections for 2013 and 2014, which indicated a continued low interest rate environment in the near term.

As a result, the REIT stocks rallied the most and outperformed the S&P 500. According to the data provided by REIT.com, on a total return basis, the broadest U.S. REIT Index – FTSE/NAREIT All REIT Index – gained 3.55%, outpacing 3.14% growth for the S&P 500 in September.

However, over the first nine months of 2013, REITs have underperformed the broad market. Total return of the FTSE NAREIT All REITs Index was up only 2.89% compared to the increase of 19.79% for the S&P 500. Notably, the FTSE NAREIT All Equity REITs Index moved north 3.03% while the FTSE NAREIT Mortgage REITs Index dropped 2.11%.

Dividends Are Key Attraction

REITs are required to distribute 90% of their annual taxable income in the form of dividends to shareholders. Yield-hungry investors thus have a large appetite for such stocks. This has enabled the industry to stand out and gain a footing over the last 15–20 years.

As of Sep 30, 2013, the dividend yield of the FTSE NAREIT All REITs Index was 4.34%. The yield of the FTSE NAREIT All Equity REITs Index was 3.68% while the FTSE NAREIT Mortgage REITs Index delivered a dividend yield of 11.33%. Clearly, the REITs continued to offer solid yields and outpaced the 2.14% dividend yield offered by the S&P 500 as of Sep 30.

Capital Access

REITs raised $60.6 billion in the first nine months of 2013. A solid IPO market in 2013 primarily made it happen.

In the first three quarters, REITs raised $3.08 billion through 14 IPOs that comfortably surpassed the $1.82 billion capital infusion through 8 IPOs in 2012. The third quarter has been the most active one with around $1.25 billion raised from 4 IPO offerings.

During the latest downturn, REITs were able to acquire premium properties from highly leveraged investors at heavy discounts. Furthermore, REITs typically have a large unencumbered pool of assets, which could provide an additional avenue to raise cash during crisis.

These assets, in turn, have provided the requisite wherewithal to the REIT industry to grow through strategic acquisitions over time. Moreover, the financing for sound properties is currently abundant as willing commercial real estate lenders continue to extend lending.

Going Forward

Macroeconomic issues and political drama have created tension in the market. According to the Fed, the tapering would occur when the economy strengthens and as per its recent statement, economic activity is expanding moderately and labor market conditions are improving. Yet, the unemployment level still remains high.

Moreover, we note that, though the third-quarter 2013 earnings picture has improved in the most recent week, the guidance still remains on the weak side, leading to negative estimate revisions at a majority of the companies.

Amid such an environment and along with disappointing government job reports, Fed’s QE program may continue for a period longer than earlier expected. This should keep the demand for high-dividend-paying REIT stocks alive.

Also, we believe that rising interest rates should not always be seen as a headwind to REIT stocks. Notably, interest rates move north when the economy gains strength and this, in general, drives demand for properties offered by REITs.

Exploring the Sector through ETFs

REIT ETFs offer a low-cost investment choice, the prospects for return from dividend income and capital appreciation as well as focus on spreading out assets among various companies and reducing company specific risk.

Vanguard REIT ETF (VNQ)

The fund, launched over nine years ago, seeks investment results by tracking the performance of the benchmark – MSCI US REIT Index – which is used to gauge real estate stocks. The fund consists of 127 stocks, which acquire office buildings, hotels, and other real property. The top three holdings are Simon Property Group Inc. (SPG), Public Storage (PSA) and Prologis, Inc. (PLD). It charges 10 basis points in fees (as of May 28, 2013). VNQ has managed to attract $33.4 billion in assets under management till September 30, 2013.

iShares U.S. Real Estate ETF (IYR)

Launched in 2000, IYR follows the Dow Jones U.S. Real Estate Index that measures the performance of the real estate industry of the U.S. equity market. The fund comprises 98 stocks with top holdings including Simon Property Group Inc., American Tower Corporation (AMT) and Public Storage. The fund’s expense ratio is 0.45% (as of September 30, 2013) and the 12-month yield is 4.05% (as of September 30, 2013). It has $4.2 billion in assets under management as of November 1, 2013.

SPDR Dow Jones REIT ETF (RWR)

Functioning since 2001, RWR seeks investment results of the Dow Jones U.S. Select REIT Index. The fund consists of 86 stocks that have equity ownership and operate commercial real estate, with the top holdings being Simon Property Group Inc., Public Storage and Prologis Inc. The fund’s expense ratio is 0.25% (as of November 4, 2013) and pays a dividend of 3.05% (as of October 31, 2013). RWR has about $2.3 billion in assets under management (as of October 31, 2013).

Schwab US REIT ETF (SCHH)

This fund debuted in 2011 and tracks the total return of the Dow Jones U.S. Select REIT Index. The fund consists of 87 stocks that own and operate commercial real estates. The top three holdings are Simon Property Group Inc., Public Storage and Prologis Inc. It charges 7 basis points in fees (as of September 30, 2013), while the trailing twelfth month distribution yield is 2.43%. SCHH boasts $549.4 million in assets under management (till September 30, 2013).

First Trust S&P REIT Index Fund (FRI)

Launched in May 2007, FRI is an ETF that seeks investment results of the S&P United States REIT Index that gauges the U.S. REIT market and retains consistency, which depicts the overall market composition. The fund comprises 139 stocks with the top holdings being Simon Property Group Inc., Public Storage and Prologis Inc. The fund’s net expense ratio is 0.50% (as of June 30, 2013) and the 12-month distribution rate is 2.61% while index yield is 3.93% as of September 30, 2013. FRI has about $164.3 million in net assets under management (as of October 31, 2013).

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