How to invest in real estate with ETFs

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If you’d like to invest in property or want to diversify your portfolio then REIT ETFs are a great way to gain exposure to the global and UK real estate markets.

How to invest in real estate with ETFs Real Estate Investment Trusts (REITs) are companies that directly own, operate or finance income-producing property. They typically focus on commercial property (shopping malls, hotels, office blocks etc) rather than residential, they are tradeable on the stock exchange, and they pool investors’ cash in diversified holdings - think of them as the equivalent of mutual funds for real estate.

 

How do REITs work?

REITs are an internationally recognised investment vehicle, first established in the US in 1960, with the goal to widen participation in real estate as an asset class. The UK turned up a little late to the game, passing REIT legislation in 2007. Qualifying criteria for REIT status varies by territory but generally, a company must: 
  
  • Invest at least 75% of its assets in property. 
  • Earn at least 75% of profits from property rent, interest on mortgages or from property sales. 
  • Pay out at least 90% of taxable income as dividends to shareholders. 
  • Have no more than 50% of its shares held by 5 or fewer shareholders. 
  • In the UK, the property rental business must include at least 3 properties and no single property may account for more than 40% of the same.
In exchange, REITs benefit from a benign tax regime. For example, UK REITs don’t pay corporation tax or capital gains tax on their property investments, unlike less efficient, older vehicles such as property companies and Property Unit Trusts. As a result, 80% of old school UK property companies (by value) have converted to REITs according to the British Property Federation. 

As with equity funds, there are different types of REITs. Some are large with highly diversified portfolios while others specialise in a particular type of real estate. For example, some REITs focus on self-storage, or doctor’s surgeries, or small business units. 90% of all REITs are known as equity REITS and invest directly in their properties. Mortgage REITs provide mortgages for property owners or buy mortgage-backed securities (MBS), while Hybrid REITs mix and match the two approaches.

 

Why are REITs better than investing directly in property?

REITs can be publicly listed and traded on the stock market just like other exchange-traded securities. That makes REITs highly liquid in comparison to single properties that can take an age to buy or sell - as any homeowner can testify. Illiquidity has often been a problem for even the listed property company vehicles. Their structure has forced some to cap redemptions during times of stress, locking in investors because the company couldn’t liquidate its holdings quickly enough.   

As pooled investment vehicles, REITs have the financial firepower to invest in multiple properties, whereas small investors are forced to place all their bets on a single property in a single market if they invest directly. You can also invest in a globally diversified REIT ETF for £50 as opposed to the millions you’d need to buy into a single, gleaming London tower. 

What’s more, you don’t need to become an expert in planning, financing, developing and maintaining property when you can outsource all that to a REIT’s management team. 

 

How do REITs fit into my portfolio?

The 10-year average annual return of REITs slightly outperformed the S&P 500 index with an average annual return of 10% even after factoring in the collapse of the housing market in 2008.

REITs are also widely used by investors interested in high dividend yields. The REIT requirement to pass on 90% of profits as dividends, plus the fact that many sign up tenants on long-term leases, makes REITs a useful source of income.  
 

How do I choose REIT ETFs?

REIT ETFs offer the same benefits as other types of ETF: a simple, transparent, affordable way to invest in a tradeable basket of securities. 

REIT ETFs track REIT equity indexes so you can profit from the return of entire property markets rather than bet the farm on a few real estate companies. Moreover, international recognition of REITs has enabled the development of low-cost global property ETFs.

If you prefer international exposure and the potential for stronger yields then look at the FTSE EPRA/NAREIT Developed Dividend+ Index. 

If you’re confident in the long-term prospects of the UK market then investigate the FTSE EPRA/NAREIT United Kingdom Index. 

Naturally, it’s important to research the composition of the indexes tracked by your short-listed ETFs. For example, the RX REIT Index only includes 3 real estate companies whereas the MSCI U.S. REIT Index is much more diversified with 151 constituents that account for the bulk of the US real estate market. Some indices will give you exposure to real estate operating companies and real estate securities too.

 

The 10 biggest real estate ETFs on the market

The table below rounds up the biggest property ETFs available to European investors. You can use our chart comparison and detailed comparison tools to assess your choices according to key indicators. Naturally, the United Kingdom is well served by real estate ETFs (property is a national obsession after all!) and 17 are available in our ETF search (as of 01/2019).
 
Source: justETF Research; as of 15/01/2019