Equity real estate investment trust (REIT) exchange traded funds (ETFs) are an easy way for investors to allocate a portion of their portfolios to the institutional-quality commercial real estate asset class.
According to Forbes, the four most popular funds are Vanguard REIT Index Fund VNQ, iShares Dow Jones US Real Estate (ETF)IYR, iShares Cohen & Steers Realty Maj. (ETF)ICF, and SPDR Dow Jones REIT ETF RWR.
The ETFs each own a basket of REIT shares in an attempt to mirror the performance of a published REIT.
In the aggregate, these four REIT ETFs account for almost 94 percent of the total REIT ETF market.
Do REITs Really Help Diversify A Portfolio?
The short answer is yes.
Owning shares of REITs in addition to bonds, stocks, CDs or money market funds, has been shown by numerous studies to result in a more diversified portfolio.
Source: NAREIT
REIT Relative Outperformance
Equity REITs outperformed the broader market post dot-com bubble, and of course during the go-go real estate bubble which burst in 2008.
However, it is notable that even during financial crises, and through the Great Recession, equity REITs outperformed both the S&P 500 and Russell 2000 indices.
All 4 REIT ETFs Performed Well This Year
Still, there was a broad range of performance due to the differences in the underlying basket of stocks that comprise the particular index being closely tracked.
Very Efficient Investments
According to Zacks, as of December 5, the fees charged for these ETFs ranged from a low of 10 bps (VNQ), to a high of only 46 bps (IYR), with the top two overall performers (ICF) and (RWR) charging fees of 35 bps and 25 bps, respectively. (Note: one hundred basis points, or 100 bps, is equivalent to a 1 percent fee).
ETFs usually have a very attractive fee structure compared to peer mutual funds.
Index funds and ETFs often perform as well or better than actively managed funds -- which typically charge higher fees. These higher fees can erode long-term portfolio performance and delay reaching financial goals, such as funding college tuition, or retirement.
Why Not Just Try The Top REITs In Each Sector?
Unfortunately, that is easier said than done.
In an ideal world, investors would be able to put together a basket of top-performing equity REIT stocks in each REIT sector, and gain alpha by outperforming the best ETFs. However, this takes time, effort, and skill-sets that many investors do not possess.
Additionally, there is absolutely no guarantee that even the most intelligent REIT investors can avoid a nasty surprise, such those that befell American Realty Capital Properties ARCP shareholders during Q4 2014.
Trying to pick outstanding individual REIT stocks, or buying the highest dividend-payers in an attempt to "chase yield" is a far riskier strategy than many might realize. This endeavor should probably be left to the experts and professional advisors.
Big Picture - Looking Forward To 2015
The end of the year is a great time for investors to review their portfolio, and meet with investment advisors with one eye focused on tax planning and the other eye focused on evaluating portfolio performance and re-balancing asset class allocations.
Investors without any exposure to the REIT asset class may want to reconsider that strategy moving forward.
Investors who owned REIT shares in 2014 saw unusually high portfolio gains.
While it is unlikely that U.S. commercial real estate will perform as well across the board in 2015, investors should still consider having exposure to institutional-quality U.S. commercial real estate as part of a long-term balanced portfolio strategy.
'Smart Money' Is Betting On International Real Estate
During 2014, top real estate alternative asset manager The Blackstone Group, LP BX has been booking gains on U.S. commercial real estate portfolios assembled after the financial crises.
Blackstone and several other U.S. firms have started buying both public and private portfolios of European, Latin American and Asian real estate assets, in an attempt to achieve more attractive returns on invested capital moving forward.
Many U.S. REITs also own international assets as part of their portfolio, such as Simon Property Group, American Tower Corp., Prologis, Inc., Digital Realty Trust and W.P. Carey Inc. By purchasing shares of REIT ETFs, investors gain some limited exposure to international real estate by virtue of their holdings.
Bottom Line
Owning shares of REIT ETFs is a cost-effective way for most investors to diversify their portfolio and benefit from the long-term appreciation and dividend income provided by the commercial real estate asset class.
Image credit: Philip Taylor, Flickr
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