For a variety of reasons, real estate investing is an incredibly attractive prospect. It’s an excellent way to diversify a portfolio, invest in something concrete, and potentially create consistent income. There are a variety of methods to get involved, ranging from buying individual properties to acquiring shares in REITS (real estate investment trusts).
REIT investments proved to be extremely profitable for those who got in early and knew what they were doing. For the last 20 years, the simplest way to outperform in this sector would have been to stock up on REITs, relish the dividends, and be patient.
Today’s prices remain acceptable, and the future return prospects appear to be bright. Most investors are aware that they should look into investing in REITs, but the question is how?
Today, an increasingly popular way of investing in the sector is through REIT ETFs.
- But first, what is a REIT?
- What is a REIT ETF?
- How do they work?
- How to invest in REIT ETFs
- Are there any drawbacks to REITs?
- The bottom line
But first, what is a REIT?
REIT stands for real estate investment trust, and they are becoming increasingly popular among investors looking to expand their portfolios beyond publicly traded stocks and funds.
Hotels, malls, apartments, warehouses, and storage facilities are examples of income-producing real estate that REITs hold and/or operate. Their allure is straightforward: the most dependable REITS have a history of paying out substantial, compounding dividends. However, depending on the type of REIT, such growth potential often comes with risk.
What is a REIT ETF?
A REIT ETF invests in shares issued by REITs, which either own, finance, or manage income-earning real estate.
REITs are by their very nature diverse, but they usually only invest in one or two subsectors. REIT ETFs, on the other hand, can give investors broader access to the various REITs that constitute this class of assets.
REITs have really aided the democratization of real estate investing by making it accessible to the general public. A corporation must pay at least 90% of its taxable income to investors as dividends to qualify as a REIT.
ETFs make a lot of sense for many investors, especially newcomers. They enable investment into the broader REIT market accessible, through ETFs such as the Vanguard REIT Fund (VNQ) or the iShares Real Estate ETF (IYR), for example.
They have a number of advantages compared to other actively managed strategies, including broad diversification, passive management, lower requirements of knowledge on the sector, and lower costs.
How do they work?
REIT ETFs have the same structure as other ETFs: a straightforward, transparent, and cost-effective approach to investing in a tradable basket of securities.
REIT ETFs pool money from a variety of investors to achieve specific goals. They let ordinary individuals invest in real estate properties, both residential and commercial, by purchasing individual REIT shares, akin to how stocks are purchased.
This means regular investors can participate without having to acquire individual properties or act as a landlord – which can be a costly and time-consuming process – as many people are either unwilling or unprepared to take on the obligations of being a landlord. It also means acquiring broad exposure to the industry with fewer transactions.
REITs are set up as ‘pass-through’ instruments, which allows them to take advantage of certain tax advantages. They’re structured similarly to companies, with a board of directors or trustees in charge.
They’ve also produced competitive total returns in the past, thanks to high, consistent dividends and long-term capital appreciation.
How to invest in REIT ETFs
A REIT ETF can be purchased with a brokerage or a retirement account. They can open an account for you through a financial institution or your workplace if you don’t already have one.
When you’ve set up your account, do some homework on the REIT ETFs that are available in order to select those that fit your investment goals and risk profile. If you’re unsure, seek advice from a financial advisor.
An important note is that the majority of REIT ETFs are almost entirely invested in large- and mega-cap REITs that are often fully or overvalued. In fact, the largest REIT ETF (VNQ) invests nearly 40% of its assets in the top ten largest REITs. These are all high-quality firms, however, the majority of them could be considered overvalued and thus have limited potential in terms of alpha-generation.
Smaller and less well-known REITs are currently trading at just 13x FFO (Funds From Operations), and if you’re diligent, you may uncover high-quality companies for as little as 10x FFO. Meanwhile, larger and more well-known REITs trade at over 20x FFO, a substantial premium above smaller REITs.
Another important note would be to not ignore international REIT markets. This is where we frequently discover the finest opportunities. They not only improve portfolio performance but also minimize risks by diversifying your investments.
Are there any drawbacks to REITs?
REIT ETFs, like any other investment strategy, have advantages and disadvantages to consider.
Most ETFs, for example, are designed to mimic the performance of an underlying index like the S&P 500 Real Estate index. But, tracking errors – a difference in performance between the ETF and the benchmark — are common due to a variety of factors, including the fund’s management costs.
However, ultimately, investing in REIT ETFs rather than individual REITs can save investors a lot of time, energy, and money. This strategy can also make it much easier for an investor to diversify their portfolio, as well as liquidate their position – I.e., selling all of their REIT ETFs in one transaction rather than selling their REIT shares one at a time.
The bottom line
Real estate ETFs are an excellent vehicle for passive investors who want to diversify their portfolios, build a steady income from dividends, and gain access to real estate, especially those investors who are unfamiliar with REITs. REITs have traditionally given investors above-average dividend income and price appreciation. When investors find it difficult to identify the best REITs for their portfolios, REIT ETFs can be a great solution.
They make it simple to participate in the REIT sector by giving investors broad exposure to the industry’s top REITs. While most REIT ETFs have similar top holdings, the best ones each have their own distinct characteristics, providing investors with a variety of excellent options.
If you’re looking for a low-cost, low-risk way to diversify your portfolio with ETFs, while minimizing potential volatility, open an arty account today and try it for FREE. arty offers a selection of well-diversified ETF portfolios that you can copy to your own ETF brokerage account.
