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All Contents © 2020The Kiplinger Washington Editors
By Steven Goldberg, Contributing Columnist
| August 7, 2018
Rising interest rates and the decline of shopping malls have weighed on real estate investment trusts (REITs) over the past few years. The good news is that many REITs – special tax-advantaged businesses provide investors with exposure to real estate – are now trading at bargain prices.
That makes now an opportune time to jump broadly into this traditionally dividend-friendly asset class via mutual and exchange-traded funds.
REITs – which own and often operate real estate such as apartments, office buildings, malls and industrial properties – get certain tax breaks, but in return must pass through 90% of their income to shareholders every year. That makes them good yield plays; currently, the average REIT yields 4%, which is higher than most stock or high-quality bond yields.
They also look cheap right now. While the Standard & Poor’s 500-stock index is trading at roughly 24 times trailing 12-month earnings, the S&P U.S. REIT sector is changing hands at a price-to-funds-from-operations (FFO, an important measure of REIT profitability) of 16.
A 5% to 10% weighting in REITs makes a good diversifier for a portfolio of stocks and bonds. While rising interest rates are considered bad news for REITs – as bonds compete with them for income investors’ money, and because much of the real estate industry is dependent on bond money – REITs historically have shown some resilience during rising-rate periods.
Investors can easily access wide swaths of this industry by investing in real estate funds and ETFs. Here’s a look at six top REIT funds right now:
Data is as of July 27, 2018.
Market value: $59.6 billion
Expense ratio: 0.26%
Minimum investment: $3,000
Vanguard is a pioneer of indexing – compiling a group of assets by using a rules-based index, such as the S&P 500, rather than a management team simply picking investments at will. And REITs are one of the many areas of the investing universe that Vanguard covers with its inexpensive index funds.
Vanguard Real Estate Index Investor (VGSIX, $26.75) tracks a wide index of REITs, with 187 holdings spanning “specialty” (29.8% of the portfolio), retail (15.8%), residential (13.4%), office-building (10.9%) and a smattering of other categories. Like most index funds, this one is market-capitalization-weighted, meaning it’s dominated by the most widely held REITs. Top holdings at the moment include telecommunications-infrastructure REIT American Tower (AMT) and mall owner Simon Property Group (SPG).
REITs are a small corner of the market, and such cul-de-sacs are theoretically good places for actively managed funds to beat simple indices. But the Vanguard fund topped 64% of actively managed REIT funds over the past 10 years. On average, it returned seven-tenths of a percentage point more per year than the average active REIT fund during that stretch.
This is also a cheap way to own a bundle of REITs and access a 3.5% yield. The Investor-class shares charge just 0.26%, or $26 annually for every $10,000 invested. The Admiral-class shares (VGSLX) charge 0.12% (with a minimum investment of $10,000), as do the ETF shares (VNQ), which have no minimum.
Market value: $3.8 billion
Expense ratio: 0.76%
Minimum investment: $2,500
Fidelity Real Estate Investment (FRESX, $41.62) manager Steve Buller has piloted this fund successfully for 20 years. He looks for REITs that own high-quality real estate assets and trade at attractive prices (much like many do now). He also employs macroeconomic indicators to help decide which subsectors of REITs to overweight and underweight.
At the moment, Buller loves industrial and office REITs (32.3% of the fund), residential (24.9%) and retail (16.6%), with the niche self-storage space also getting about 9% of the fund’s assets. Simon is the top holding in this fund, and it’s joined by the likes of logistics REIT Prologis (PLD) and storage king Public Storage (PSA).
FRESX has returned an annualized 8% over the past 10 years, topping the S&P US REIT index by an average of one-half of a percentage point annually; it’s also ahead of the index by an average of 0.6 percentage points annually over the past three years. Moreover, FRESX has beaten the average real estate fund in 15 of the 20 years Buller has been at the helm. That’s lifted in part by a decent dividend that currently yields 2.7%.
The fund is hardly bulletproof. Fidelity Real Estate Investment was crushed in 2007, tumbling 21% and finishing in the bottom decile among its peers. It lost even more, 38%, in 2008 … but that actually was slightly above-average among its competitors.
Buller is a patient investor, though. The average security stays in the fund for about four years.
Market value: $5.2 billion
Expense ratio: 0.73%
Virtually every real estate fund is a little different from its peers. T. Rowe Price Real Estate (TRREX, $27.62), for instance, tends to hold more “traditional” REITs (residential, office, retail, hotels) and fewer specialty REITs such as those that deal in cell towers and data centers. The top two holdings, for instance, are a pair of apartment plays: AvalonBay Communities (AVB) and Equity Residential (EQR).
The lack of data-center REITs specifically has held TRREX back over the past few years. The fund also has a somewhat low 2.3% yield. Still, Manager David Lee, like Fidelity’s Buller, has run this fund – and run it well – for 20 years. The Fidelity offering has outpaced the T. Rowe fund by an average of 1.5 percentage points over the past 10 years. But the T. Rowe fund is less volatile than the Fidelity fund. TRREX tends to hold positions much longer, at an average of 10 years – a distinct plus for investors who want a consistent portfolio.
Market value: $1.2 billion
Expense ratio: 0.14%
Investors interested in geographic diversification can look to the iShares Global REIT ETF (REET, $25.53) – an exchange-traded fund that blends international and domestic REITs.
In this case, REET is roughly 65% invested in American REITs such as Simon Property Group, Prologis and Public Storage. The rest is spread among developed countries including Japan, Australia and the United Kingdom. The only two foreign REITs that crack the top 10 are French retail play Unibail-Rodamco-Westfield SE (UNRDY) and Hong Kong-based retail-and-office-space company Link REIT, which is Asia’s largest real estate investment trust.
As is the case with most foreign stocks, foreign REITs, as well as this global fund, have trailed their U.S. brethren over the past three years by an average of half a percentage point per year. You also have to worry about international concerns such as currency risk.
Still, the foreign diversification does provide a nice hedge should U.S. real estate take a step back. The yield, at 4%, isn’t anything to sneeze at either.
Market value: $6.7 billion
Expense ratio: 0.34%
The Vanguard Global ex-U.S. Real Estate Index Fund (VGXRX, $23.50) is a better choice if you want strictly international exposure.
Unlike the iShares Global REIT ETF, Vanguard’s ex-U.S. fund has no exposure to American REITs. Also, it has much more exposure to emerging-market real estate companies, so you can access faster-growing parts of the world as well. Developed countries including Japan (22.2%), Hong Kong (12.9%), Australia (8.2%) and the U.K. (7%) still dominate assets under management, but China (10.9%), South Africa (2.1%) and the Philippines (1.4%) are among countries that give the fund a roughly one-fifth weight in emerging markets.
Like many index funds, it’s market-cap-weighted, too, meaning the largest real estate stocks – such as Unibail and Hong Kong’s Sun Hung Kai Properties – are the biggest holdings.
Foreign REITs often pay higher yields than U.S. REITs; to wit, VGXRX yields a generous 4.7%.
The Investor-class shares charge 0.34% and require a minimum of just $3,000. The Admiral-class shares, VGRLX (minimum investment: $10,000), and the ETF, VNQI, charge just 0.14%.
Market value: $4.3 billion
Expense ratio: 0.97%
Minimum investment: $10,000
Cohen & Steers is known for its focus on real estate investment trusts. And its Cohen & Steers Realty Shares (CSRSX, $63.00) is an old-fashioned mutual fund – with all the positives and negatives that implies.
A trio of managers examines everything from the underlying value of each REIT’s properties to the macro outlook for commercial real estate. From this process, the team builds a portfolio of between 40 and 60 REITs. The fund overweights and underweights real estate subsectors depending upon the managers’ outlook. Offices (14%), apartments (13%) and data centers (12%) are tops right now, with industrial (6%) and infrastructure (4%) among the smaller industries.
Returns have been good. Over the past 10 years, the fund returned an annualized 8.3% – an average of 0.7 percentage points annually than the FTSE NAREIT All Equity REITs Index.
There are a couple downsides, however. For one, the 0.97% expense ratio is a handicap against the super-low-cost index competitors. Also, the fund has grown to $4.3 billion in assets, making it one of the largest actively managed REIT funds – and that makes it more difficult to trade smaller REITs.
On the negative side, the 0.97% expense ratio isn’t particularly high for an actively managed mutual fund, but it’s still a significant handicap against super-low-cost index competitors.
Steve Goldberg is an investment adviser in the Washington, D.C., area.