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.

 

 

 

4 Replies to “Discovering Value in the Top 3 REIT ETF’s”

  1. Hi Michah,
    I am a very small investor starting off a portfolio. I am based in Ireland, and am part of an investment group/learning program. All us Irish participants have been disappointed recently to discover that any EU regulated funds are taxed really stringently, so I have to now go through my 8 ETF’s, and for any EU regulated ones, I am liquidating and moving to a non-EU equivalent. One of these was my property ETF.

    I’ve been reading your blogs regularly and you seem to endorse accumulator ETF’s, but you are recommending REZ here, and I have a basic question, I cannot see on the REZ ETF Fact Sheet whether it is an accumulator or not?

    Your feedback is welcome!

    1. Hi Emma
      I apologize, but I think there is a difference in meaning of the word ‘accumulator’ in Ireland than the way I am using it. I am using ‘accumulator’ in reference to being in the accumulation phase of my investment journey. REZ is an ETF that I want to accumulate; meaning I don’t intend to sell it any time soon. I’ve looked through the prospectus and fact sheet for REZ and only found one reference to ‘accumulate’ which is; “If the Fund’s distributions exceed current and accumulated earnings and profits, all or a portion of the distributions made in the taxable year may be recharacterized as a return of capital to shareholders.” This doesn’t sound like what you are talking about to me. Could you please send me a link to something that explains how the word “accumulator” is used in reference to financial products in Ireland. I would be very grateful to learn this information.
      Thank you
      Micah

      1. Hi Micah,

        Thanks for your prompt response. An ‘Accumulator’ ETF is the recommended form of ETF for us (in my investment learning group), as it is effectively compounding – ie all dividends are automatically reinvested into the fund. Like you, the goal is to ‘set and forget’ for a period of anything from 8-15 years, and to maximise return with the compounding element.

        It seems from my research (and I am way behind you!), that EU regulated funds are more often ‘Accumulator’ than US funds, but EU regulated funds are taxed very harshly and it’s a right pain in the portfolio 😉 if you invest monthly, as I do.

        The Irish Revenue/taxation model favours lump sums, and it is better from our perspective to invest in what the Irish Revenue call ‘Bad ETF’s’ – ie non-EU regulated, because the taxation is far more lenient. The Revenue don’t ‘punish’ you for investing in ‘bad’ ETF’s, by the way, we are perfectly entitled to do it, they are ‘bad’ from Revenue’s perspective because THEY make less on them!
        BUT, outside the EU it’s hard to find funds that compound, or accumulate. It would wreck your head trying to navigate it all!

        Anyway, thank you for clarifying your use of the word ‘acccumulator’. I enjoy your blog and I have invested in a couple of ETF’s based on your recommendations/research already.

        Warmly
        Emma

        1. Thanks Emma, I now have a much better understanding of the Irish system and the use of the term accumulator. I would say that REZ and most other U.S. REIT ETFs are not considered accumulator funds because they do not reinvest the dividends into the fund; they pay all dividends out. In fact, by definition, REITs in the U.S. must pay nearly 100% of their income out as dividends. Therefore, the REIT and REIT fund investors are responsible for the taxes on that income. This is why, in the U.S. it’s recommended to hold REITs in tax advantaged accounts such as 401k’s and IRAs. I hope this helps.
          Thank you
          Micah

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