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3 U.S. REIT ETFs to watch in 2023
Investors looking for affordable, diversified real estate exposure can consider these ETFs.
Debates about whether or not real estate investment trusts, or REITs actually qualify as a separate, distinct asset class still rage on today. On one hand, you have prominent and respected industry professionals like Rick Ferri giving them a dedicated allocation in his "Core-Four" series of portfolios along with the usual stocks and bonds.
On the other hand, there are academic studies arguing that REITs are not a distinct asset class, but rather just a stock market sector that should be weighted according to its market cap in a portfolio. The popular Rational Reminder podcastasserts that the risk/return profile of REITs is basically the same as a portfolio of 60% small-cap value stocks and 40% high-yield bonds.
Regardless of your view on REITs, its hard to deny their historical diversification benefit and returns. From 1994 to the present, REITs returned an annualized 8.71%, but with a 0.62 correlation to U.S. stocks. Assets with a positive expected return and low correlation make for excellent diversifiers.
Overall, 2022 was a poor year for REITs thanks to rising interest rates. As interest rates rose, property values fell, which increased REIT borrowing costs. Higher yields on lower risk fixed income securities also made the distribution yields of REITs less attractive relative to their higher risk.
Still, there aren't many assets that beat REITs for their exposure to real estate prices. They offer strong, consistent income potential without the capital and time needed to get a rental property going. Aspiring real estate investors can use the following low-cost ETFs to instantly own a portfolio of REITs.
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Vanguard Real Estate ETF (VNQ)
A highly popular, low-cost option among passive investors is VNQ, which tracks the MSCI US Investable Market Real Estate 25/50 Index. This ETF tracks 167 real estate sector stocks weighted by market capitalization, with a median market cap of $24.4 billion making it skewed towards large caps.
One thing to note about VNQ is its allocation to non-REIT stocks, which are mostly real estate development, operating, or service companies. The allocation to these is quite small at around 4.4% total, but the ETF is definitely not a pure-play REIT fund.
VNQ is highly popular for two reasons: high diversification and low fees. The ETF holds diversified, healthcare, hospitality, industrial, office, residential, and retail REITs. Its annual expense ratio amounts to just 0.12% or $12 for a $10,000 investment.
iShares Core U.S. REIT ETF (USRT)
A potential alternative to VNQ is USRT. Investors who dislike VNQ for its non-REIT holdings might like USRT better given that this ETF is a pure REIT play, with no real estate service, operating, or development companies in its holdings.
Otherwise, both ETFs are fairly similar. USRT has a total of 140 holdings, with many of its top holdings like Prologis REIT, Equinix REIT, Public Storage REIT, Welltower, and Realty Income REIT also making an appearance in VNQ. USRT is also slightly cheaper with a 0.08% expense ratio.
One thing to note is that despite having similar holdings to VNQ, USRT actually tracks a different index, the FTSE NAREIT Equity REITs Index. Therefore, it could potentially be a great tax-loss harvesting partner for VNQ, especially given that REITs are in the red year-to-date.
Real Estate Select Sector SPDR Fund (XLRE)
State Street offers a suite of 11 "Select Sector" SPDR ETFs, each corresponding to one of the 11 GICS market sectors represented in the S&P 500. XLRE is the ETF that represents REITs and real estate management/ development companies (excluding mortgage REITs) in the S&P 500.
As a result of this concentrated approach, XLRE tracks a much smaller portfolio than VNQ or USRT. The ETF currently has 31 holdings with a weighted average market capitalization of $45 billion, making it skewed toward large caps. This is unsurprising given the S&P 500's composition.
However, when compared to VNQ and USRT, XLRE still has many of the same top holdings, albeit in higher allocations. This is a result of each ETF using a market-cap weighted methodology. As a result, XLRE could be used as another tax-loss harvesting partner. The ETF costs an expense ratio of 0.10%.
Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.
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