Real Estate Investment Trusts (REITs) are a popular way for people to invest in real estate without having to buy and manage properties directly. A REIT ETF (Exchange-Traded Fund) takes this concept even further by allowing investors to gain broad exposure to the REIT market without needing to pick and analyze individual companies. In this article, we’ll introduce you to REIT ETFs that focus on targeting the broad U.S. real estate market. We will explain their characteristics and what to consider before investing.

What Are ETFs? 

An Exchange-Traded Fund, or ETF, is a type of investment fund that holds a collection of assets, such as stocks or bonds. It trades on a stock exchange, just like a single stock. Most ETFs are passively managed, meaning they aim to replicate the performance of an index—such as the S&P 500—and they offer an efficient way for investors to get broad exposure to a sector, asset class, or strategy. REIT ETFs hold portfolios of REITs, seeking to replicate the performance of a real estate index. This approach allows you to invest in a wide variety of properties through a single fund.  

Overview of Diversified US REIT ETFs 

There are nine REIT ETFs traded in the U.S. with over $500 million in assets under management (AUM), which focus on the US market:

Name Ticker Expense Ratio (%) Assets Under Management ($ mil) Number Of Holdings Vanguard Real Estate ETF VNQ 0.13% 37,600 159 Schwab U.S. REIT ETF SCHH 0.07% 7,323 120 The Real Estate Select Sector SPDR Fund XLRE 0.09% 6,938 31 iShares U.S. Real Estate ETF IYR 0.39% 4,457 65 iShares Core U.S. REIT ETF USRT 0.08% 2,772 134 iShares Cohen & Steers REIT ETF ICF 0.33% 1,961 30 SPDR Dow Jones REIT ETF RWR 0.25% 1,855 103 Fidelity MSCI Real Estate Index ETF FREL 0.08% 1,100 150 iShares Residential and Multisector Real Estate ET REZ 0.48% 1,066 39 JPMorgan BetaBuilders MSCI US REIT ETF BBRE 0.11% 915 119

All those ETFs track broad real estate indices, which are diversified between many real estate sectors. There are other smaller funds with a similar strategy, but they do not offer any significant advantage over the larger ones. Also, there are smaller funds with different strategies, but we will discuss them in another article. Most of these large funds have been around for over a decade.

Expense ratios

One notable difference between these ETFs is their expense ratios—the fees charged to manage the fund. The expense ratios range from as low as 0.07% to as high as 0.39%. Since all these funds follow roughly the same strategy of providing exposure to the U.S. REIT market, there’s little reason to pay higher management fees. Generally, choosing a REIT ETF with a low expense ratio is a better choice for long-term returns.

Diversification Benefits 

Those ETFs provide diversification by investing across multiple real estate sectors. These sectors include residential, retail, office, industrial, healthcare, and more. Typically, no one sector represents more than 20% of the total holdings, which reduces risk. For example, one sector may face challenges, like retail properties struggling due to changing shopping habits, while another, such as industrial properties, may perform well due to the growth in e-commerce. Although these ETFs provide diversification, the investment risk is not negligible. Some real estate sectors that those funds hold, such as hotels and offices, are considered more risky than others.

Many REIT ETFs also include sectors like timber REITs under a category called “Other.” Additionally, some ETFs include real estate service companies, which are not classified as REITs but contribute to the overall performance of the real estate sector. Most ETFs also have significant holdings (around 10%) in Telecom Tower REITs, while three of the large funds (USRT, RWR, BBRE) do not hold Telecom Towers at all. Following is a description of the indices that each ETF follows:

Performance and Returns 

Although these ETFs replicate different indices, their overall performance is quite similar. The average ten-year performance across these funds shows low variation, suggesting that the differences between the indices they track are not significant. Since it is difficult to predict which index will outperform in the future, we think that the choice of an ETF, among those, should not be primarily based on the specific index it replicates.

As of 2024, rising interest rates over the past three years have negatively impacted commercial property values and increased borrowing costs for REITs. As a result, average returns for large REIT ETFs have been flat, around 0% for the past three years. The U.S. REIT market saw negative returns in 2020 (due to COVID) and in 2022 (due to rising interest rates), which significantly impacted recent returns. If we look at the five-year performance of U.S. REIT ETFs, they averaged about 3.8% annually, while the ten-year average was 5.8%. Some older funds have annual yields in the range of 7% to 9%, depending on the year they were created.

The Vanguard Real Estate ETF (VNQ), the largest REIT ETF, has shown considerable variability in returns since 2009. The worst year was 2022, with a -26.2% return, while the best year was 2021, with a return of 40.3%. Over a 16-year period, VNQ had only three years with negative returns, and the decade before COVID showed very positive returns with an average of 11.95% annually (contributed by the decreasing interest rate environment).  Considering that current interest rates are not low and not expected to increase substantially, we believe that future REIT sector returns could improve compared to the past decade’s average, but will likely fall short of the strong gains seen during the 2010-2020 period.

Index Tracking Error

A tracking error is the difference between the fund’s performance and the index it is trying to replicate. For most REIT ETFs, this difference is minor and is largely driven by the fund’s expense ratio. Funds with higher expense ratios tend to have lower net returns for investors. For instance, the iShares U.S. Real Estate ETF has an expense ratio of 0.39%, while the iShares Core U.S. REIT ETF has an expense ratio of 0.12%. Over the past decade, the iShares Core ETF provided a higher average annual return compared to the standard iShares ETF, mainly due to its lower fees. This makes it clear why selecting a low-cost REIT ETF is generally the best choice.

Price to NAV and Bid/Ask Spreads

The price-to-NAV (Net Asset Value) spread is another concept to understand. It refers to how closely the market price of the ETF matches its underlying asset value. For those large U.S. REIT ETFs, this spread is usually very small, which means that investors can be confident that they are buying at a fair price. You can check on the website of each fund its current NAV and the market price spread from NAV.

Bid/ask spreads, which indicate the difference between what buyers are willing to pay and what sellers are asking, are also very tight for these large ETFs, typically between 0.01% and 0.03%. This means investors are unlikely to face significant costs when buying or selling shares of these funds.

Conclusion 

Diversified U.S. REIT ETFs offer an accessible way to invest in a broad range of real estate assets acros various real estate sectors. There is not much difference in asset allocation or performance among these large REIT ETFs, one of the biggest factor affecting returns is the expense ratio. Choosing an ETF with a low expense ratio, like the Vanguard Real Estate ETF (VNQ) or iShares Core U.S. REIT ETF, is a sensible strategy for most investors. By understanding what sectors these ETFs cover and being aware of costs like the expense ratio, investors can make more informed decisions to build their real estate portfolios.

Disclaimer: The information provided in this post is for informational purposes only and reflects my personal opinions. It should not be considered as professional financial, legal, or investment advice. Please consult with a professional before making any investment decisions. I am not responsible for any actions taken based on this information. The full disclaimer can be found here.