What it means
A real estate investment trust, or REIT, owns properties such as offices, warehouses, apartments or shopping centres and passes most of its income to shareholders. In the United States a REIT must distribute at least 90% of its taxable income to shareholders to keep its special tax status.
A REIT ETF bundles many of these companies into one fund. Buying the fund spreads an investor's money across dozens or hundreds of REITs and property types.
This lowers the risk that one weak company or one troubled sector will dominate the outcome. Costs are usually low, shown as an expense ratio, which is the annual fee as a percentage of assets.
The fund passes on the dividends it receives, so REIT ETFs are often chosen for income. Their prices still move up and down with interest rates, property values and the stock market.
When interest rates rise, REIT prices often come under pressure because borrowing costs rise and bonds become more attractive. There are different kinds of funds.
Some track a broad index of US REITs, others focus on a property type such as healthcare or data centres, and some invest globally. Investors should check what the fund holds, how concentrated it is and how closely it follows its index.
Compared with owning property directly, a REIT ETF is far more liquid and needs no management work or large deposit. The trade-off is that the investor has no control over individual properties and faces stock market price swings.
Tax treatment of the dividends is also different from ordinary company dividends, so investors should seek advice. Taxes deserve a mention.
Distributions from REITs are often taxed differently from ordinary company dividends, and the details depend on the investor's country and type of account. Holding a REIT ETF in a tax-advantaged account can change the picture, so investors should ask a qualified adviser.
In practice
Real-world examples.
Example
A retired teacher wants income from property without buying a rental unit. She invests $40,000 in a broad REIT ETF and receives quarterly distributions.
Example
A business owner already owns his factory and wants more diversification. He buys a REIT ETF that focuses on healthcare and logistics property so that his wealth is not tied only to his own building.
Example
A portfolio manager uses a REIT ETF as a quick way to increase property exposure in a client account before choosing individual holdings. The fund can be sold the same day if the client's plans change. The manager also checks the fund's top holdings so that the account does not end up overweight in one company.
Formula
Calculation
Annual fund cost = amount invested x expense ratio
Annual income = amount invested x distribution yield
An investor puts $50,000 into a REIT ETF with an expense ratio of 0.12% and a distribution yield of 3.5%. Annual fund cost = $50,000 x 0.0012 = $60. Annual income = $50,000 x 0.035 = $1,750. The cost of $60 is already reflected in the fund's performance, and the yield will vary from year to year.Case study
Seen in the real world.
Linden Family Office is an illustrative, fictional investor with $5,000,000 to allocate. It wanted 10% in real estate but did not want the work of buying and managing buildings.
The family bought $500,000 of a diversified REIT ETF. Over the following year, rising interest rates caused the fund's price to fall, yet its distributions continued and the family could sell in a day if needed. The illustrative lesson is that a REIT ETF offers easy access and liquidity, but its price moves with markets, not with slow-changing property valuations.
Linden also used the REIT ETF as a temporary home for the money while it studied direct property deals. When it later found an attractive private opportunity, it sold part of the fund within a day and used the cash, which showed the value of the liquidity.
Watch out
Common mistakes.
- Assuming a REIT ETF is as stable as owning a building, when its price changes daily with the stock market.
- Choosing a fund on yield alone, when high yield can reflect risk or a falling price.
- Overlooking concentration, when some funds are heavily weighted toward a few property types or a few large companies.
Questions
People also ask.
Is a REIT ETF the same as a REIT?
No, a REIT is a single company, while a REIT ETF is a fund that holds shares in many REITs.
Do REIT ETFs pay dividends?
Yes, they pass on the dividends received from the REITs they hold, usually paid out quarterly.
How are they affected by interest rates?
Rising rates often put pressure on REIT prices, while falling rates tend to help, though other factors such as rent growth, vacancy and the wider economy also matter.
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