Real estate investment trusts, also known as REITs, provide investors with the opportunity to earn profits from real estate investments without the need to purchase, manage, or finance physical properties. REITs are favored by investors for their ability to diversify a portfolio, as they have lower correlations with the performance of stocks and bonds.
When considering REIT investments, dividend yields are a crucial factor to examine, as dividends play a significant role in the overall return of a REIT. However, choosing the right REIT requires thorough research to ensure a wise investment decision.
For investors seeking attractive REIT returns without the extensive research, a REIT exchange-traded fund (ETF) can be a suitable solution. A REIT ETF offers exposure to the real estate sector along with diversification, reducing the risk associated with individual REIT investments.
Listed below are some of the most popular REIT ETFs available in the market. (Data sourced from Morningstar as of July 30, 2024)
Top REIT ETFs
Prior to investing in a REIT ETF, it is advisable to review the fund’s prospectus to understand its investment strategy and holdings.
Vanguard Real Estate ETF (VNQ)
The Vanguard Real Estate ETF stands out as one of the most popular REIT ETFs. This fund tracks an index of companies engaged in owning and operating real estate properties throughout the United States.
- 5-year returns (annualized): 2.0 percent
- Dividend yield: 4.2 percent
- Expense ratio: 0.13 percent
iShares U.S. Real Estate ETF (IYR)
Among the oldest REIT ETFs, the iShares U.S. Real Estate ETF follows an index of U.S. companies directly or indirectly involved in the real estate sector, similar to the Vanguard fund mentioned above.
- 5-year returns (annualized): 3.9 percent
- Dividend yield: 2.9 percent
- Expense ratio: 0.40 percent
Real Estate Select Sector SPDR Fund (XLRE)
This ETF represents the real estate sector within the S&P 500 index, investing in large-cap real estate companies operating in the United States.
- 5-year returns (annualized): 5.4 percent
- Dividend yield: 3.6 percent
- Expense ratio: 0.09 percent
iShares Global REIT ETF (REET)
The iShares Global REIT ETF tracks a global index of real estate companies operating in emerging and developed markets, including the United States.
- 5-year returns (annualized): 1.5 percent
- Dividend yield: 3.1 percent
- Expense ratio: 0.14 percent
JPMorgan BetaBuilders MSCI U.S. REIT ETF (BBRE)
This ETF follows an index of small-, mid-, and large-cap companies primarily involved in commercial and specialized real estate across the United States.
- 5-year returns (annualized): 4.8 percent
- Dividend yield: 3.4 percent
- Expense ratio: 0.11 percent
Understanding REITs
REITs invest in various real estate properties such as residential apartments, office buildings, hospitals, data centers, hotels, and retail stores. Some REITs focus on specific market areas like mortgage financing, while others have diversified investments across the real estate market. The risk profile of a REIT depends on the assets it holds.
To qualify as a REIT, a company must adhere to certain requirements, including distributing a minimum of 90 percent of its taxable income to shareholders as dividends.
Most REITs fall into three categories: equity, mortgage, and hybrid. Equity REITs directly own real estate or land, while mortgage REITs hold mortgages on real estate, potentially through mortgage-backed securities. Hybrid REITs combine elements of both types.
Pros and Cons of REIT ETF Investments
Advantages of REIT ETFs
- Strong total returns. Equity REITs have delivered an average annual return of 7.9 percent over the past 20 years through September 2023, according to Nareit, slightly behind the annual return of the Russell 1000 large-cap index at 9.8 percent.
- Steady passive income. REIT ETFs offer a consistent stream of passive income for dividend investors without the complexities of property ownership or management.
- High liquidity. Publicly traded REIT ETFs are highly liquid, allowing investors to access their principal at any time the market is open, a convenience not easily achievable with physical real estate.
- Diversification benefits. REITs can serve as a diversification tool in a portfolio due to their lower correlation with other asset classes like stocks.
Disadvantages of REIT ETFs
- Volatility. Similar to other equity investments, REIT ETFs can be volatile and susceptible to rapid losses, a characteristic less prominent in physical real estate investments.
- Reliance on capital markets. REITs are required to distribute a significant portion of their taxable income to investors, leaving fewer funds for potential investment opportunities. They often need to access debt and equity markets to expand, and high market rates can hinder growth within the sector.
- Tax implications. Dividends from REITs are typically taxed as regular income, potentially subjecting them to higher tax rates than qualified dividends.
Investing in REIT ETFs
An effective dividend strategy can play a vital role in any investor’s portfolio, especially when dividends are reinvested for increased returns.
When selecting REIT ETFs, consider the following four steps:
1. Define your financial objectives
Your investment choices should align with your financial goals. For instance, individuals nearing retirement may opt for a more conservative investment approach. Always let your financial objectives guide your investment decisions.
2. Research REIT funds
When evaluating REIT ETFs, focus on factors such as dividend track record, dividend yield, fund performance, expense ratios, top holdings, and assets under management. This information can usually be found in a fund’s prospectus or on its website.
3. Establish your asset allocation
Prior to investing, assess your current holdings and determine how you wish to distribute your assets. Remember, maintaining diversification is key, and a REIT fund can form a significant part of your overall portfolio.
4. Understand your investments
Regularly review your investment portfolio to take control of your finances and make necessary adjustments. Utilize resources provided by your broker, such as consulting with a financial planner, and always seek clarification when needed. Remember, there is no such thing as a completely hands-off investment.
Similar to any other investment, REIT ETFs carry inherent risks. However, the extent of potential losses is linked to the risk level associated with the portfolio. A fund heavily invested in riskier assets, such as highly-leveraged real estate companies, will have a different risk profile compared to a fund invested in established, reliable entities.
Where to Purchase a REIT ETF
REIT ETFs can be acquired through any of the leading brokers specializing in stock trading.
— This article was updated with contributions from Bankrate’s Brian Baker and Jim Royal.
Editorial Disclaimer: It is recommended that all investors conduct independent research into investment strategies before making any investment decisions. Additionally, past performance of investment products does not guarantee future price appreciation.