REITs are typically used for diversification and/or income generation in long-term investment portfolios. Below we’ll check out the best REIT ETFs to get exposure to the real estate market in 2021.
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In a hurry? Here’s the list:
- VNQ – Vanguard Real Estate ETF
- VNQI – Vanguard Global ex-U.S. Real Estate ETF
- REET – iShares Global REIT ETF
- SCHH – Schwab U.S. REIT ETF
- USRT – iShares Core U.S. REIT ETF
- REZ – iShares Residential Real Estate ETF
Introduction – Why REITs?
Real Estate Investment Trusts, or REITs for short, are an efficient and effective way to get exposure to the real estate market to diversify one’s investment portfolio without buying physical property. Better yet, REIT ETFs provide broad exposure to national and international commercial and residential real estate markets by pooling investor capital and diversifying their real estate buys, thereby allowing investors to avoid the idiosyncratic risks of local real estate markets inherent with owning property.
We would expect private property ownership to generate the highest returns because it cuts out all the middle men. Unfortunately, buying real estate directly has a lot of obvious downsides. It requires management, upkeep, and knowledge of the local market. It also exposes you to unsystematic, localized risks, as well as potential illiquidity when you want to sell. Owning real estate can be more like running a business than an investment. Do you want to be a landlord? Equity REITs solve all these issues.
Think of REITs like baskets of real estate properties that trade on exchanges. You’re sacrificing some expected return by having to pay a bit for the management of that basket, but you don’t have to lift a finger other than sitting at your computer and placing a buy order for the REIT fund. REITs also act as a decent inflation hedge because landlords can directly pass on inflation costs to tenants in the form of higher rents.
REIT portfolios can include apartment complexes, data centers, hospitals, hotels, cell towers, office buildings, retail spaces, warehouses, and more. REITs may offer a diversification benefit to long-term investment portfolios by being lowly correlated to both stocks and bonds. This means when stocks or bonds fall in value, REITs may rise in value. These correlations have shifted over time, but we wouldn’t expect REITs to be perfectly correlated with common stocks anyway, as their fundamental risks are different.
Remember, diversification is the only opportunity for a free lunch in investing. The inclusion of REITs in a portfolio has indeed basically been a free lunch historically, boosting returns while lowering volatility. This means a greater risk-adjusted return (Sharpe), or alpha, the holy grail of investing. Here’s a backtest from 1990 through July, 2021 comparing a 60/40 portfolio with 10% REITs on the equities side versus a 60/40 portfolio without a dedicated allocation to REITs:
To be fair, one thing to note is that the portfolio with REITs still had a larger max drawdown, as REITs sometimes become highly correlated with the broader market during crashes.
Long-term leases mean rents are more stable than corporate earnings. That stable cash flow from rentals is precisely what drives REIT returns, as opposed to capital gains with equities. Lastly, landlords are also not trying to bring new products or services to market, meaning they have less business risk than a typical corporation.
REITs are also popular among income investors as they typically have a high dividend yield. REITs are required to generate 75% of their income from real estate investments, and are also required to distribute 90% of that income to shareholders, hence their high yields that income investors love. In doing so, REITs aren’t subject to corporate income tax on those profits.
Note that REITs are relatively tax-inefficient due to their high yield and mostly unqualified dividends, so they are best held in a tax-advantaged accounts like a Roth IRA or 401k.
REIT ETFs provide cheap and easy access to that diversification and dividend yield. Let’s explore the best REIT ETFs.
The 6 Best REIT ETFs
Below are the 6 best REIT ETFs:
VNQ – Vanguard Real Estate ETF
The Vanguard Real Estate Index Fund (VNQ) is far and away the most popular REIT ETF out there, with over $50 billion in assets. The fund seeks to track the MSCI US Investable Market Real Estate 25/50 Index, providing broad exposure to the U.S. real estate market. This ETF has over 180 holdings and an expense ratio of 0.12%.
VNQI – Vanguard Global ex-U.S. Real Estate ETF
Diversifying internationally with REITs may be prudent, as U.S. and international REITs are actually lowly correlated to each other. The Vanguard Global ex-U.S. Real Estate ETF (VNQI) provides exposure to international REITs outside the U.S.
The fund tracks the S&P Global ex-U.S. Property Index, providing exposure to REITs in over 30 countries around the world. This ETF has over 640 holdings and an expense ratio of 0.12%.
REET – iShares Global REIT ETF
Want a single fund for both U.S. and international REITs? REET is basically the sum of VNQ and VNQI above. It has about $3.3 billion in assets and seeks to track the FTSE EPRA Nareit Global REITs Index.
The downside is you’ll pay a tiny bit more for that simplicity and convenience. REET has an expense ratio of 0.14%.
SCHH – Schwab U.S. REIT ETF
Another low-fee option for U.S. REITs is from Schwab – the Schwab U.S. REIT ETF. It launched in 2011 and has over $6 billion in assets.
SCHH can be considered comparable to VNQ above and is conveniently cheaper by 5 bps. It’s actually the cheapest ETF on the list with an expense ratio of 0.07%. This ETF seeks to track the Dow Jones Equity All REIT Capped Index, excluding mortgage REITs.
USRT – iShares Core U.S. REIT ETF
The iShares Core U.S. REIT ETF (USRT) seeks to track the FTSE NAREIT Equity REITs Index. The fund was established in 2007.
For all intents and purposes, USRT should also be considered comparable to VNQ, except USRT isn’t quite as concentrated in its top holdings as VNQ and SCHH.
USRT has over $2 billion in assets and an expense ratio of 0.08%.
REZ – iShares Residential Real Estate ETF
All the preceding REIT ETFs hold mostly commercial real estate. To specifically target residential, healthcare, and public storage REITs, the iShares Residential Real Estate ETF (REZ) is a great choice. This ETF seeks to track the FTSE NAREIT All Residential Capped Index and has an expense ratio of 0.48%.
Where To Buy These REIT ETFs
All these REIT ETFs should be available at any major broker. My choice is M1 Finance. M1 has zero trade commissions and zero account fees, and offers fractional shares, dynamic rebalancing, and a sleek, user-friendly interface and mobile app. I wrote a comprehensive review of M1 Finance here.
I actually created this REIT pie for M1 Finance that provides roughly 50/50 exposure to U.S. commercial and residential REITs, since again most of the REIT ETFs above are dominated by commercial REITs, which have underperformed residential REITs historically.
Disclosures: I am long VNQ in my own portfolio.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.