NEW YORK (Fabian Capital Management) -- Real estate investment trusts, or REITs, have come a long way from the drubbing they experienced this time last year. The Federal Reserve-induced taper tantrum led to a significant selloff in these income-generating vehicles that was primarily driven by rising interest rates and the fear of a slowing real estate market.
The majority of REIT ETFs fell between 15%-20% in a two-month time frame that culminated in an excellent opportunity for value-seeking investors to purchase these funds at attractive price points and much higher yields. Since that selloff we have seen a complete price retracement back to the prior highs as yield-hungry buyers have stepped back into the real estate game.
One of the attractive attributes of REITs is they are considered an alternative asset class with different risks and growth drivers than traditional stocks and bonds. This makes them an excellent opportunity to diversify your portfolio in an unconventional asset class, in addition to adding a much higher yield than the average dividend-paying stock.
In fact, REITs are generally required to pay out the majority of their taxable income as dividends to shareholders.
In terms of size, the largest and most heavily traded ETF in this space is the Vanguard REIT ETF (VNQ). This fund is comprised of 137 publicly traded REITs with a total portfolio size of $23.1 billion. The top two holdings in the market-cap weighted VNQ include Simon Property Group (SPG) and Public Storage (PSA). However, the fund is widely diversified in a number of hotel, healthcare, office, retail, and residential REITs.
Probably the most attractive quality of VNQ over similar broad-based real estate competitors such as the iShares Real Estate ETF (IYR) is its miniscule expense ratio. VNQ currently charges a tiny 0.10% management fee compared to 0.46% for IYR. The only lower-cost vehicle in its class is the Schwab U.S. REIT ETF (SCHH), which touts an expense ratio of just 0.07% annually.
VNQ has an effective yield of 3.70% based on the most recent distribution and income is paid quarterly to shareholders. So far this year, VNQ has gained 17.01% as the combination of favorable real estate data and falling interest rates have been a tail wind for higher prices.
REITs are often very sensitive to changes in interest rates because their financing and acquisition costs are heavily reliant on a favorable yield environment. Investors typically shun REITs in a rising rate environment because the additional risks you assume to own these companies versus other income opportunities become less attractive as bond yields rise.