Ask the Manager: David Auerbach on Fixing the REIT Yield Problem

In this edition of Ask the Manager, we caught up with David Auerbach, CIO of Hoya Capital Real Estate, to break down how RIET achieves nearly double the yield of traditional REIT ETFs.

By screening for quality and emphasizing income, RIET reshapes how investors access yield.

David shares why this structure may be more aligned with real estate investors’ goals.

Can you walk us through the selection and weighting process behind RIET’s high-income portfolio?

RIET exclusively targets the income side of the real estate sector, using rules-based index to select 100 common and preferred securities issued by U.S. exchange-listed REITs. RIET expects to pay monthly distributions and the Index Dividend Yield as of 6/30/2025 was 9.91%.

The multi-factor selection process is designed to manage risk through broad diversification across fourteen property sectors and three market capitalization tiers, and includes a quality screen to identify real estate companies with lower leverage profiles.

Once selected, the 100 constituents are equally-weighted within three tiers with a maximum weight at each semi-annual rebalance of 1.5%. 

 What do you mean by “focus on the income side” of the REIT sector?

The "focus on income side of the REIT sector" is a reference to the fact that the large-cap indexes have become increasingly dominated by a handful of lower-yielding large-cap property sectors - cell towers, data centers, logistics REITs.

The result is that these broad-based averages - and the huge ETFs that track them (VNQ, etc) - have seen their dividend yields compress to levels - below 3% - that most investors wouldn't be expecting in their REIT allocation. 

RIET takes a more novel approach in that it considers size as a tertiary factor in the index weighting system rather than the one-and-only factor considered.

Instead, RIET considers dividend yield as a primary factor in the selection process, and then considers property sector and company size as a means to manage risk and achieve more balanced diversification.

The inclusion of REIT preferred securities - which are more fixed-income-like and historically less volatile than common stock - is also a novel approach at the ETF-level and should help to "smooth out" the return characteristics and income potential of the fund. 

For reference, the largest 10 holdings in the cap-weighted indexes comprise 40% or more, and in several ETFs, it's not uncommon to see single-stock weights of 20% for the largest securities.

In my view, this kind of concentration kind of nullifies the primary advantage of the ETF structure - efficient diversification. If your fate is sealed by the performance of 5-10 stocks, why not just do it yourself?

By comparison, RIET invests across 100 securities and the largest single-stock weighting is set at 1.5% at index rebalancing for the largest REITs while the potentially more volatile small-cap REITs have even lower single-stock weights. 

By taking this approach, RIET is able to achieve a yield that is more than twice that of the market-cap-weighted averages and doing so in a portfolio that doesn't go "all-in" on any single property sector or leave investors exposed to outsized idiosyncratic risks that you'd often find with more concentrated portfolios of high-yielding REITs. 

How is the yield so high compared to other REIT funds?

There's nothing particularly complex about RIET. We often say - there's more yield out there in the REIT space than some folks realize - particularly when you look beyond the largest 20-30 REITs - and by combining several factors/skews, you can quite easily get into the high-single-digit yield range. 

We designed the index in-house with a specific income objective while seeking to minimize risk through diversification across property sectors, market capitalization tiers, the inclusion of preferred securities (in addition to common), and small individual position sizes. 

More specifically - compared to the market-cap weighted benchmarks, RIET achieves this premium yield through 1) overweight mid-cap and small-cap REITs; 2) overweight income-focused property sectors (including mortgage REITs); and 3) the inclusion of REIT preferreds. 

Despite the yield-focus, you'll note that we've tracked the broader benchmarks quite closely since inception.

We benchmark against the Dow Jones US Real Estate Index, which is a commonly used and industry standard cap-weighted index.

We've consistently been plus-or-minus a couple of percentage points of this benchmark since inception (Sep 2021) - which we're quite pleased with given the objective of targeting or "extracting" yield from the REIT sector while maintaining risk characteristics of a standard REIT index. 

What are benefits of including preferreds? 

Preferred securities are often – and increasingly – overlooked as their use has been phased out by many companies outside the finance and real estate space. But the preferred market in real estate is as fertile and active as any other equity sector.

There are roughly 175 exchange-traded preferred securities issues by U.S. REITs, and about a third of REITs have preferred issues. In the REIT sector, essentially all of these issues are “cumulative” which means that REITs must pay all preferred distributions before they can pay a penny to the common shareholders, which naturally gives these securities an extra layer of dividend protection.

You saw the risk-mitigating features of preferreds play out last year where many REITs slashed their common dividends but never missed a single penny on their preferred dividends.

And among the REITs that have both common and preferred issues, their preferred stock only declined in price by about half during the worst of the drawdown last year.

As you note, many of the popular real estate CEFs have blended preferreds into the REIT funds for many years – and with significant success.

Again, we like – and have recommended - the Cohen & Steers suite of real estate CEFs, despite the sky-high fee load. So with RIET, we think we’re able to offer something comparable but at a fraction of the cost.

Why Include Mortgage REITs?

For RIET, we started with the yield "objective" and the goal was to create a portfolio that was optimized from a risk/return perspective for that given target.

By comparison, HOMZ is definitely more total return oriented and I think it's strong performance is a result of the bias towards growth and quality. (it's consistently been one of the top 1-2 real estate ETFs since its launch in 2019)

We decided to include commercial mREITs because for that given yield, these have historically performed better than a similar mix of equity REITs in this yield range based on our analysis.

And I think the relatively stronger performance from mREITs than eREITs at that given level does make fundamental sense - mREITs effectively "lever-up" a portfolio of lower-risk assets while eREITs in that yield range are typically yielding up there because of quality-related reasons.

We've warmed up to mREITs over the years and have been happy to see the corporate governance improve across most of the sector. And in fact, I think mREITs may actually be under-appreciated from a risk/return perspective.

The historical performance - while lagging eREITs by ~1-3% per year over long time periods - is still quite solid and when you consider the percentage of it that comes from dividends, I think one can make the case that if the singular objective is income/dividends, that mREITs are quite efficient.

Do you have a target market for RIET? Does it mainly appeal to retail investors?

Before launching our first ETF – HOMZ - back in 2019, we were active investors in many different real estate ETFs and CEFs and and published research about some of the strengths and idiosyncrasies of many of the funds.

The two areas that we saw the most room for improvement – and needed some innovation - were in the housing space and in the higher-yield space.

Back in 2018 when we began conducting the research to put these indexes together, we decided to start with the housing space, which lacked an ETF that truly captured the entire housing universe. There were homebuilder ETFs and there were REIT ETFs, but certainly nothing that combined these two housing categories into a single fund.

Despite being a new issuer with a limited marketing budget, we were able to get HOMZ off the ground, no doubt helped by the fact that it’s consistently been one of the top-performing real estate ETFs since its launch back in 2019.

So the success of HOMZ has given us the resources and the platform to launch the second fund – RIET - which has been in the pipeline for a half-decade now. Similar to HOMZ, we set out to “solve a problem” rather than to just create a ”product to sell” or chasing the latest hot trend.

We tried to make the objective for REIT as simple as possible, which is reflected in the tagline of the fund:  “When seeking income in real estate, just remember ‘I Before E’ in RIET, because Income Comes First.”

We think that the appeal of an “income first” real estate fund with a well-researched index selection process – and at a low cost compared to the alternatives – has wide appeal not only from self-directed investors, but also among the larger institutional asset managers.

RIET is designed to provide diversified exposure to 100  of the highest dividend-yield real estate securities. Is it more heavily weighted to certain sectors or property types than others?

Not unlike the broader equity market, real estate is an enormous asset class with a distinct mix of higher-yield and higher-growth property sectors, and within those property sectors, there’s typically a mix between REITs focused more on longer-term growth and those focused on returning capital to shareholders. 

Among the roughly 220 U.S. exchange-listed REITs – the majority of which are mid-caps and small-caps– the average dividend yield is around 4.5% - and that’s just on the common stocks. When you include the universe of REIT preferred stock as well, the average yield jumps to nearly 6%.

However, not unlike what you’re seeing in other benchmark indexes like the S&P 500, market-cap-weighted REIT indexes have become increasingly dominated by a handful of mega-cap – and low-yielding – technology names, which drag that average yield down closer to 3%.

While names like American Tower, Crown Castle, and Equinix have been strong performers in recent years, investors that simply need the income yield are finding it increasingly difficult to find in the cap-weighted real estate indexes.

So consistent with the “income first” theme of the fund, the index selection rules in RIET prioritize the property sectors – and REITs within those sectors – that tilt towards the higher-yield side of the yield/growth spectrum.

So put simply, RIET achieves its premium yield by ditching the constraints of the market-cap-weighted structure and instead uses the rules-driven process to exclusively target the income-side of the real estate sector.

Specifically, the RIET selection process begins by selecting "Dividend Champions" using a quality screen to identify REITs with lower leverage.

Dividend-paying common and preferred stocks issued by U.S. listed REITs – 100 in total – are then selected based primarily on dividend yield, subject to diversification requirements across property sectors and market capitalization tiers.

Do the higher yields also come with higher risk? Aside from diversification, are there other ways that RIET is mitigating risks for investors (i.e. choosing companies that have strong balance sheets/lower leverage?)

At the single-stock or single-bond level, indeed, higher yield tends to be correlated with higher levels of risk. When investing in the higher-yield segments of the market, the need for diversification and additional levels of risk controls becomes absolutely essential.

Importantly, unlike most other issuers in the space, we’re 100% focused on the real estate markets, which I think gives us a bit of an edge in understanding how to control and manage the risk inherent with investing in the higher-yield space in the REIT sector.

Within the REIT sector, managing property sector exposure is critical when it comes to managing risk, and explains the bulk of the outperformance/undeperformance that any given REIT portfolio will see in any given period.

Market cap exposure is also an important factor, as you often see extended periods where small-cap REITs persistently underperform despite otherwise comparable fundamentals performance.

This fund leans heavily on the risk-mitigating benefits of diversification through the rules-based process. With 100 components in the tiered equity weight system – with no single component above 1.5% - you remove a lot of the company-specific risk.

Then you layer in the property sector categorization - which limits the exposure to sector-specific risks (retail, office, etc) - and the market-cap categorization, all of which are factors that we’ve researched extensively specifically within the confines of the REIT universe.

The result is a level of risk control that we’re quite comfortable with based on extensive back-testing and scenario analysis, while at the same time, achieving a premium dividend yield relative to the market-cap-weighted REIT indexes.

Of course, investing in 100 stocks within one’s real estate allocation  would be extremely challenging and time-consuming at the individual portfolio level, but with the scale of the ETF, we’re able to do it with a high degree of efficiency.

And it’s interesting because you see a lot of other products out there that don’t really maximize this benefit of the fund wrapper in my personal opinion as both an investor in these indexes and a REIT and ETF analyst.

You look at other dividend-focused real estate products that have just 30 stocks or the market-cap-weighted indexes in which the Top 10 holdings are just 40-60% of the fund, and I think you lose a lot of the core benefit of the ETF model – the efficient diversification.

So in short, we created RIET to address a need of our own clients, and by extension, the need of many investors seeking income in a diversified turn-key package.

Currently, there are about 3 dozen REIT ETFs with big names like Vanguard and Blackrock competing for capital. What’s your strategy for attracting investors?

I think that the early success of our first fund – HOMZ – confirms our belief that investors recognize the value of investing alongside a specialist in the real estate industry and in high-conviction concepts that are supported by research and fundamentals.

Real estate is our focus 24/7/365, and with more than 200 individual REITs across more than a dozen property sectors – and many of which have multiple classes of stock, the sector really does require a dedicated focus.

And moreover, I think that investors are increasingly seeing the inherent shortfalls of the simple market-cap-weighted approach in the real estate sector, particularly for investors seeking income.

Cell Towers, for instance, represent up to 20% of some of the cap-weighted indexes even though the total value of towers is only about 1% of the total U.S. real estate market.

Regardless of one’s outlook for that sector, by investing in cap-weighted indexes, there’s an inherent “active” bet on factors that have little to do with fundamentals, and more to do with somewhat random dynamics.

So our strategy continues to lean heavily on investor education, research, and transparency.

We’ve published hundreds of research reports and white papers about the real estate sector and have built-up an audience through this platform, and the products and indexes that we build are heavily influenced by the feedback that we receive from these investors and market participants.

What’s your outlook for continued growth in the Real Estate ETF space and why? Do you think the REIT ETF space is too crowded, or is there still room for new players and more differentiation?

From out vantage point, the real estate ETF marketplace is only in the 2nd or 3rd inning – which is even earlier in the “life cycle” than the broader ETF industry which I’d say is closer to the 5th inning.

Despite the significant inflows into real estate ETFs from relatively higher-fee and less tax-efficient mutual funds and closed end funds, ETFs still represent just a small slice – roughly a quarter by our estimates – of the total invested assets in real estate funds.

And within that quarter, the vast majority of investors still use the traditional market-cap-weighted products that, in my view, aren’t fully aligned with the actual investment objectives of many investors in real estate sector – particularly those seeking income.

But I think you’ve started to see the beginning of some excellent innovation in the real estate ETF marketplace over the last half-decade including with the sub-sector-focused products offered by the teams at Benchmark and Fundamental Income, which are again in response to some of the shortfalls of the cap-weighted approach.

More broadly, I think you’re also seeing a broader “institutionalization” of the U.S. real estate markets which, over time, will result in a higher share of assets owned by publicly-traded entities. You see that most prominently in the single-family rental sector, but even there, institutional investors like REITs still own just 2-3% of single family homes.

And these trends are overall net positives, in my view, as REITs have always been pioneers in the democratization of real estate investing and tend to be leaders when it comes to tenant customer service and corporate governance.

So we’ve extremely optimistic on the overall outlook for the real estates sector – and our corner of the marketplace in the ETF world.

We’ve been encouraged to see another 50 REITs raise their dividends this year after over 80 last year, which has underscored the point that the sector appears to now be stronger fundamentally than it was pre-pandemic.

And with these dividend hikes, real estate has once again become one of the most attractive asset classes for investors seeking income, and we think that RIET is particularly well-positioned to capture these compelling opportunities.