A REIT, or real estate investment trust, is a special class of company that must deliver 90% of its taxable income back to shareholders, This is in exchange for preferential tax treatment of its operations.
This tradeoff was developed in part because REITs require a lot of capital to own or maintain massive real estate holdings. The thinking goes that if you incentivize this structure of business, the companies can provide economic growth potential – as long as they pass some of their success on to shareholders if things work out.
This creates a mandate for big dividends as a result, which is one of the big appeals of REITs.
And in addition to boasting some of the highest dividend yields, REITs are much cheaper to buy than physical real estate as you only have to meet the sticker price on a single share.
The upsides of investing in real estate investment trusts is pretty clear. But instead of researching individual stocks, which can be quite complex, most investors should instead focus on how to find the best REIT ETFs instead.
ETFs, or exchange-traded funds, are diversified baskets of assets. And with a lot less homework and stress, you can effectively invest in a wide swath of these real estate stocks in one single holding.
So how do you find the best REIT ETFs? Here are three suggestions:
Look for funds with $100 million or more in assets. There are occasionally good exchange-traded funds that aren't well-established, but they are exceptions to the rule. So make sure you are going with a recognizable asset manager, with at least $100 million in total assets under management for the fund in question.
That figure may sound like a lot, but keep in mind that funds charge expenses much less than 1%. This means tiny funds either don't make a lot of money and are at risk of folding the fund unexpectedly… or they are forced to overcharge investors to keep the lights on.
Find ETFs with expense ratios of 0.40% or less. This is your investment fee expressed as a percentage. So the math on this adds up to $40 per year on every $10,000 invested. Many funds charge less than that, but that should be your ceiling.
The average expense ratio of stock-focused ETFs is just 0.16% at present, and some of the best REIT ETFs even come in under that bar. It's OK to pay a bit more for a fund that's a better fit, but keep in mind that every penny in fees is a penny you don't pocket in profits.
Seek out yield of 2.5% or better. Income is a big feature of real estate investment trusts, so don't shortchange yourself when it comes to regular payouts. The current yield of the S&P 500 Index as a whole is about 1.6% at present, and some of the best ETFs in the REIT space pay more than twice that amount.
Most investors considering the best REIT ETFs are typically diversified across more than 100 individual holdings in their portfolio that include commercial real estate, residential housing, and even industrial park or specialized telecom REITs.
It would take a lot of know-how to build a portfolio like that on your own, as well as requiring an extensive amount of time to manage. That's why many investors prefer REIT ETFs as their one-stop shopping destination.
Here are the largest exchange-traded funds that primarily hold U.S. real estate investment trusts, according to VettaFi.
Vanguard Real Estate ETF (VNQ): $32.05 billion in assets under management, 0.12% in annual expenses, 4.25% yield
Schwab U.S. REIT ETF (SCHH): $6.4 billion in assets under management, 0.07% in annual expenses, 3.32% yield
Real Estate Select Sector SPDR Fund (XLRE): $6.0 billion in assets under management, 0.09% in annual expenses, 3.55% yield
iShares U.S. Real Estate ETF (IYR): $3.0 billion in assets under management, 0.40% in annual expenses, 2.91% yield
iShares Core U.S. REIT ETF (USRT): $2.4 billion in assets under management, 0.08% in annual expenses, 3.25% yield
There are indeed other REIT ETFs out there that may be a good fit for your personal portfolio.
It's also worth noting that there are international ETFs with a real estate tilt such as the Vanguard Global ex-US Real Est ETF (VNQI), a well-established and affordable fund. If you are interested in looking outside the domestic real estate market, these funds are worth exploring more.
But as with anything, the answer to what is the "best" is subjective. So while finding the best REIT ETFs should involve a look at the size and cost of the funds, you still have to explore the makeup of each fund to decide what fits best with your portfolio. For more aggressive investors, that might mean an overseas REIT fund with huge dividends. For others, it could mean a more modest payday but a focus on well-established domestic leaders.
What's best for you will not be the best for your neighbor. But for most investors, if you look at large-sized REIT ETFs with an affordable expense ratio, you will be on the right track.
