Discovering Value in the Top 3 REIT ETF’s

Do you own an IRA, 401k or other tax sheltered Retirement Savings Account? If so, you would be wise to consider adding a Real Estate Investment Trust (REIT) ETF to your portfolio. The two main reasons I recommend REIT ETF’s are 1.) they have a relatively low correlation to the US Stock Market (0.57 over the last 22 years) and 2.)  they have outperformed the S&P 500 during that same time by 68 basis points (CAGR Compounded Annual Growth Rate).

The primary reason that I have a REIT ETF in my portfolio is for the arbitrage that can be taken advantage of during periodic re-balancing. This is why investment advisers recommend non-correlated assets. While one fund is ‘zigging’, another may be ‘zagging’, and therefore can lend itself to an advantageous re-balancing opportunity.

Since I have determined that I will hold a REIT ETF in my portfolio, I did my due diligence to pick what I believe is the best ETF in this asset class for me.

During my research, I first back-tested the REIT asset class as far back as I could, which was from 1994 through 2016. In this chart, pay particular attention to the US Market Correlation.

Next, I back-tested the oldest REIT ETF, IYR, iShares U.S. Real Estate ETF against the SPDR® S&P 500® ETF, SPY. During the 2000 to 2016 time frame note that REIT’s massively outperformed the US large cap blend asset class.

The third step in my analysis was to look at all the real estate funds in existence according to etfdb.com. Currently there are 41 real estate ETF’s listed. I did not consider any leveraged or inverse funds in my research. I also eliminated any funds newer than October 2007. The reason behind this is that I want to know how a fund might perform during a significant bear market. After this elimination process, I was left with 15 REIT ETF’s to back-test. My back-test analysis helped me determine that the three with the best performance were: 1) REZ, iShares Residential Real Estate Capped ETF, 2) VNQ, Vanguard REIT ETF and 3) ICF, iShares Cohen & Steers REIT ETF. In this chart, note that in the shorter time frame from 2007 through 2016 REIT’s do not outperform the S&P 500:

Earlier I showed the performance of IYR over SPY from 2000 through 2016. It obviously performed quite well over the long-term, so you may be wondering why it’s not included in the top three ETF’s. Well, here’s the back-test I performed to why it’s not included:

In addition to the out-performance that is apparent in the REZ ETF, there are other features about this ETF that helped me decide that this is the REIT ETF for my portfolio. First of all, it primarily holds residential, healthcare and self-storage real estate REIT’s, as opposed to commercial real estate (think shopping malls) which most of the other ETF’s hold. Second, the REIT’s inside this ETF generally have smaller capitalization than those in the other ETF’s and I believe there is still a small cap premium available in the stock market

You may be wondering why I started this article with the question about tax sheltered accounts. The reason behind this is that you do not want to hold REIT’s in a brokerage account because they are not tax efficient. In other words, the dividends, which are a significant portion of the total return on a REIT ETF are taxed at a higher rate than regular equity ETF dividends. You can get more details about REIT’s and taxes at this website: Why You Should Exclude REITs From Taxable Accounts.

Thank you for reading, The Deep Value ETF Accumulator, aka Micah McDonald

Thank you porfoliovisualizer.com for the back-testing tools.

Thank you etfdb.com for the ETF research tools.

 

 

 

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