Choosing a Real Estate ETF

We have a range in our portfolio allocation model specifically dedicated to diversified real estate holdings. Real Estate is an important piece in building that ever elusive diversified portfolio. Quite simply, we have maintained a 0% allocation for some time. As you can imagine, it has affected our performance.

We track the price through DJ Wilshire REIT ETF (RWR), which peaked on 2/7/07 at $99.86. When it hit a low on 5/24/07 of $84.47, we started contemplating adding a position. RWR has moved quite quickly in the last few days back to $90.91 (close 6/4). This price movement has prompted us to evaluate both our potential investment vehicles and weighting in the category.

The highlights of that review follow below:

Included in our review are RWR, DJ Wilshire International Real Estate ETF (RWX), iShares Dow Jones U.S. Real Estate Index Fd (IYR), iShares Cohen & Steers Realty Majors Index Fd (ICF), Vanguard REIT ETF (VNQ) and First Trust S&P REIT Index Fd (FRI). These are the most prevalent broad based diversified ETF Real Estate vehicles offered.

The one thing to be cognizant of is that all the funds in the review have different benchmarks. One would think there would be some type of huge difference. It is amazing the similarity in price moves when graphed.

The funds with the longest tenure, ICF, IYR and RWR, have 5 year annualized numbers of 23.54%, 20.57% and 22.31%, respectively as of 3/31/07.

We knocked FRI off the list first. Out of all the funds, except RWX, it had the highest expense ratio. Even worse, there is a small clause that states the expense ratio is being artificially kept low until at least two years after the public offering. Additionally, the market cap range between IYR and FRI are very similar.

Next we dropped ICF due to its concentration on large market cap. Once again, the expense ratio is marginally higher and we wonder if the out performance is temporarily due to sector favoritism.

This brought us down to four: VNQ, RWR, IYR and RWX. At this point we used P/E, P/B, Exp ratio and dividend yield to help further differentiate the funds. One caveat is that dividend is current distribution, so it is a poor indicator. We will list them in the above order.

VNQ: P/E 44.24 P/B 3.74 Exp .12% Div 2.35%
RWR: P/E 42.41 P/B 4.18 Exp .25% Div 2.50%
IYR: P/E 39.70 P/B 3.92 Exp .48% Div 3.15%
RWX: P/E 20.08 P/B 2.07 Exp .60% Div 1.29%.

Given this overlay, we are surprised at the current elevated P/E and P/B Ratios in contrast to RWX. RWX is a foreign Real Estate fund. It was introduced on 12/19/2006. Although comprised with different weights and allocations, we can’t help but wonder if this still indicates a US real estate market, which is ahead of itself compared to the rest of the world. Economic theories pop to mind, such as The Law of One Price and Purchasing Power Parity or, even better, The Big Mac Index. If we were to move into US Real Estate, it would be with either RWR or IYR on a valuation stand point.

However, given the above notions, we are going to take a small position in RWX. We will look for a further pull back in US Real Estate funds before taking a position. Accordingly, a non-US and eventual US position would seem to bode well for the diversified Real Estate portion of the portfolio.

Comments

[Eddie Wilson]

Why does VNQ get knocked out here? Has the lowest expense ration, and makes the other cuts noted. Then, all of a sudden, it is missing from the recommended list. What gives?