Investing in a REIT ETF gives investors a chance to collect income while diversifying their portfolio. A REIT is a real estate investment trust. Companies that operate as REITs own and operate income producing real estate, as well as other real estate assets.
The great thing about these investment vehicles is that give investors a chance to gain exposure to the commercial real estate market. Normally, the cost of owning commercial real estate is out of the question for small investors. However, the creation of REIT ETFs makes it possible.
What Does A REIT ETF Invest In?
A REIT ETF invests in REIT stocks. That said, for a company to be considered a REIT it must invest at least 75% of its total assets in real estate and cash. Also, it must derive at least 75% of its gross income real estate and other related sources, these include: rents from rental property and interest on mortgages financing real estate property.
But that’s not all.
REIT stocks must be taxed as a corporation. Also, it must have no more than 50% of its shares held by five or fewer individuals during the last half of the taxable year. Furthermore, it must derive at least 95% of its gross income from real estate activities and dividends or interest from any source. Lastly, it can have no more than 25% of its assets consisting of non-qualifying securities or stocks in taxable REIT subsidiaries.
What Type Of REIT Stocks Does A REIT ETF Invest In?
There are three different types of REITs that REIT ETFs invest in. They include: Mortgage REITs, Hybrid REITS, and Equity REITs.
A Mortgage REIT provides financing for income producing real estate. It’s accomplished by purchasing or putting together mortgages and mortgage-back securities. It also earns income in the form interest from these investments.
An Equity REIT invests and owns properties. It acquires, manages, builds, remodels, and sells real estate assets. It generates revenue from rental properties. Types of rental properties include: hotel, industrial, residential, commercial, and retail.
A Hybrid REIT is simply a combination of a Mortgage REIT and Equity REIT.
The Best REIT ETFs To Buy
iShares U.S. Real Estate ETF (NYSE: IYR) gives investors exposure to U.S. real estate companies and REITs. It is traded on the stock market making it easily accessible to any investor with a brokerage account.
The ETF seeks to track investment results of an index composed of U.S. equities in the real estate sector.
Top ten holdings include: American Tower REIT; Simon Property Group REIT; Crown Castle International REIT; Prolologis REIT; Equinix REIT; Public Storage REIT; Weyerhaeuser REIT; Avalonbay Communities REIT; Equity Residential REIT; and Digital Realty Trust REIT.
Investors of the ETF get an annual dividend of $2.87 per share.
Vanguard Real Estate Index Fund (NYSE: VNQ) invests in stocks issued by REITs, companies that purchase office buildings, hotels, and other real property. It attempts to track the return of the MSCI US Investable Market Real Estate 25/50 Transition Index.
The ETFs top ten holdings include: Vanguard REIT II Index Fund; Simon Property Group Inc; Equinix Inc.; Prologis Inc.; Public Storage; AvalonBay Communities Inc; Digital Realty Trust Inc.; Equity Residential; Welltower Inc; and Ventas Inc.
Source: The Vanguard Group, Inc.
The fund gives its investors an annual dividend of $3.31 per share.
Real Estate Select Sector SPDR Fund (NYSE: XLRE) seeks to provide an accurate picture of the real estate sector of the S&P 500 Index. Its focus is companies from real estate management and development and REITs, excluding mortgage REITs.
The top ten holdings of the fund include: American Tower Corporation; Simon Property Group Inc.; Crown Castle International Corp; Prologis Inc; Equinix Inc; Public Storage; Weyerhaeuser Company; AvalonBay Communities Inc; and Equity Residential.
Investors of the fund receive an annual dividend of $1.02 per share.
What Risks Do REIT ETFs Have?
One factor that might hurt the REIT market is inflation. When interest rates rise the cost of borrowing becomes more expensive, increasing the chances of a sell off in REIT stocks.
Real estate has been traditionally viewed as a safe investment. And for most Americans it will be the largest investment they make in their life. However, the financial crisis of 2008 taught us that even real estate can be risky.
That said its important to follow whats happening with the overall economy as well as specific trends in the real estate market before deciding to invest in a REIT ETF.
When the economy experiences a downturn, investors and businesses become more cautious. This could potentially affect occupancy rates, as well as the price of rental properties. If its harder for businesses to get access to capital, less projects will be developed and some might get abandoned like we saw during the financial crisis.
Contrarian REIT ETF
If you’re bearish the REIT market there is an ETF for you. ProShares Ultra Real Estate (NYSE: SRS) seeks a return that is two times the inverse return of the daily performance of the Dow Jones U.S. Real Estate Index for a single day.
That said, the fund is better for day trading than it is for investing due to its leveraged nature.
REIT ETFs give investors an opportunity to gain exposure to forms of real estate that they normally wouldn’t have access too. That said, they pay investors income via a dividend. But, there is still risk investors need to be aware of before deciding to invest in a REIT ETF.
Traditional real estate investments are not liquid. On the other hand, you can trade in and out of a REIT ETF with ease. Furthermore, this type of flexibility makes them more attractive to some investors over traditional real estate investments.
The Federal Reserve Banks offer investors data on the housing and real estate market. For example, you can find data on: commercial real estate prices; real estate loans at commercial banks; delinquency rate on commercial real estate loans; owners equity in real estate; real estate loans; and much more.
Source: St. Louis Fed
As with any investment make sure to do your own due diligence.