From the September 2011 issue of Investment Advisor • Subscribe!

August 24, 2011

Why REIT ETFs?

Income-starved investors hunting for additional revenue streams pounced on real-estate-investment-trust-related exchange-traded funds this year.

With bond yields at historical lows, investors turned to investments that offered any form of decent yields. As such, REITs have attracted their fair share of market interest. Assets in the ETF category rose 60% for the past year. The asset class climbed nearly 200% since the March 2009 lows and gained more than two times the broader U.S. market.

How They Work
Companies generate revenue from rent collected on properties. REITs then pay out a hefty chunk of their net income to shareholders through dividends in order to qualify for federal tax breaks.

By pooling assets together, REITs reduce risk and provide greater diversification since capital is distributed through numerous properties. If an individual were to mimic such a strategy, one would have to buy multiple properties. Investments in REITs are also a more efficient diversifier because REITs are more liquid compared with investments tied to physical property.

The Caveat
The largest risk that REIT investors face is the ability of the companies to collect rent. If the commercial side of the market weakens, that could weaken the yields to the point that shareholders no longer find them of value. Additionally, GDP, job growth, corporate profits and consumer confidence are also major factors to consider when gauging economically sensitive REIT ETFs.

Interest rates are already very low. As interest rates eventually increase, REITs may experience higher costs in capital, diminished cash flows and depressed asset values.

REIT ETF Options
The largest is the Vanguard REIT Sector ETF (VNQ), with $9.5 billion in assets. VNQ has an expense ratio of 0.13% and a current yield of 3.6%. The fund provides exposure to a diversified range of the various types of REITs, such as industrial and office buildings, residential, hotels and other real estate property.

Among the more targeted REIT ETF options, the iShares FTSE NAREIT Mortgage REITs Index Fund (REM) is the largest, with $212.8 million in assets. REM has an expense ratio of 0.48% and its current yield is 10.61%. This type of REIT ETF provides a targeted exposure to a specific area of the real estate market. In the case of the REM ETF, mortgage REITs, which include residential and commercial real estate, make up 71.88% of the overall holdings of the fund and 22.93% of the fund comes from banks that provide mortgage financing.

Investors who want to diversify REIT investments through global holdings may consider international REIT ETFs that target specific countries or regions. SPDR Dow Jones International Real Estate ETF (RWX) is the biggest, with $2.3 billion in assets. RWX has an expense ratio of 0.59% and yields 2.05%. The fund has a significant portion of its holdings in real estate operating companies, diversified, regional malls and office space. The ETF invests more than a third of its assets in Japan and Australia.

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