The Best REIT ETF

REITs are publicly traded corporations that invest in real estate. The REIT ETF can help you diversify among REITs.

There are three types of REITs: Equity REITs, mortgage REITs, and hybrids.

Equity REITs own commercial real estate and usually specialize in a particular type of property such as shopping centers, office buildings, residential (apartments) or hotels. However, a few are "diversified REITs" because they own properties in multiple categories.

Mortgage REITs don't own property outright but instead invest in real estate mortgages. They profit by borrowing money at short-term rates and then investing in long-term real estate loans. Mortgage REITs do well in a low interest rate environment because they borrow money at low rates, buy high-interest, long-term assets and profit from the spread.

Hybrid REITs contain a little bit of both.

It is reasonable to expect equity REITs to produce a dividend yield between 4% to 9% and a Mortgage REIT to have a 12% - 20% dividend yield. This is because REITs operate under special tax rules and don't pay income taxes as long as they pay out at least 90% of their taxable income to shareholders.

However, these tax rules result in most property REITs needing to raise capital by borrowing or by selling more share to fund growth which is not good for existing investors. On the bright side, this pass through results in the high dividends which I pointed out earlier. The tax rules also mean that REIT dividends are usually taxed as regular income instead of the lower 15% capital gains rate. However, you may get lucky if a REIT designates some portion of its payouts as "qualified dividends," (which then qualifies for the maximum 15% rate). A REIT may also be able to classify portions of its prior year payouts as return of capital (which reduces your cost basis and are not taxable until you sell your REIT shares).

Also, while dividends on REITs can be attractive they can and do cut or suspend dividends at anytime, with little or no notice so their share price can be volatile.

One way to try and reduce the volatility is to invest in REIT ETFs. Since REITs are a collection of properties or mortgages, a REIT ETF is like a fund of funds broadening your holdings.

Finding the Best REIT ETF

• Yield. REITs usually have a substantial yield.
• Dividend Growth. Look for a REIT with dividend growth. The higher payouts increase your yield and the dividend increase usually drives the share price higher.
• Funds From Operations (FFO). Investors and analysts pay attention to funds from operations (FFO) when investing in REITs. FFO is basically income excluding depreciation. FFO is significant for REIT investors because FFO growth drives dividend growth. A 5% to 10% annual FFO growth is reasonable. You should also calculate how much of the FFO is used to pay dividends. Just like dividend payout ratio a lower number is better. For example, REITs with ratios below 80% outperform REITs with ratios above 90%.

A Short List of REIT ETFs To Check Out

iShares

• Cohen & Steers Realty Majors Index Fund (ICF). Broad REIT index of the largest, most liquid REITs.
• Dow Jones U.S. Real Estate Index Fund (IYR). Broad REIT index.
• FTSE NAREIT Industrial/Office Capped Index Fund (FNIO). Industrial and office real estate.
• FTSE NAREIT Mortgage Plus Capped Index Fund (REM). Residential and commercial mortgage, mortgage finance and savings associations.
• FTSE NAREIT Real Estate 50 Index Fund (FTY). 50 largest REITs within the FTSE NAREIT Composite Index.
• FTSE NAREIT Residential Plus Capped Index Fund (REZ). Residential real estate, healthcare and self storage.
• FTSE NAREIT Retail Capped Index Fund (RTL). Retail property
• FTSE EPRA/NAREIT Developed Asia Index Fund (IFAS). Asian real estate market.
• FTSE EPRA/NAREIT Developed Europe Index Fund (IFEU). European real estate market.
• FTSE EPRA/NAREIT Developed Real Estate ex-U.S. Index Fund (IFGL) Canadian, European, and Asian real estate.
• FTSE EPRA/NAREIT North America Index Fund (IFNA). North American real estate.
• S&P Developed ex-U.S. Property Index Fund (WPS). Real estate companies outside of the United States.

S&P SPDRs

• Dow Jones REIT ETF (RWR). Companies that own and operate commercial real estate in the United states.
• Dow Jones Global Real Estate ETF (RWO). Real estate securities (commercial and/or residential real estate including mortgage REITs, health care REITS, netlease REITs, real estate finance companies, mortgage brokers and bankers, commercial and residential real estate brokers and estate agents, home builders, large landowners and subdividers of unimproved land, hybrid REITs, and timber REITs) in developed and emerging countries.
• Dow Jones International Real Estate ETF (RWX). Real estate securities in developed and emerging countries outside the United States.

Powershares

• Active U.S. Real Estate Fund (PSR). Real estate companies within the U.S.

WisdomTree

• WisdomTree Global ex-US Real Estate Fund (DRW). Large cap real estate companies outside the U.S.

Return from REIT ETF to Index Investing