A Real Estate Investment Trust For Your Portfolio

| About: Vanguard REIT (VNQ)

Summary

I recently reviewed the Seeking Alpha ETF Investing Guide and decided to implement it for a portion of my portfolio. Previous articles reviewed the first eight ETFs in the guide.

This article reviews Vanguard REIT ETF, the ninth of ten ETFs in the core portfolio of Seeking Alpha’s ETF Investing Guide.

REITs and VNQ have run up pretty fast since bottoming in 2009. I will likely add VNQ to my portfolio after some additional research.

The Seeking Alpha ETF Investing Guide

I recently reviewed the Seeking Alpha Investing Guide and decided to allocate part of my portfolio to a core portfolio of ETFs, similar to that suggested by the guide. I do not intend to completely switch course from my current allocation but to set up a separate core portfolio of ETFs and to allocate a majority of my investments to this Core ETF portfolio over time.

After reviewing the investing guide, I drafted a procedure for implementing the suggestions of the guide. Currently I am reviewing each of the suggested ETFs to determine which to buy. This article focuses on the real estate investment trust (REIT) portion of the Core ETF portfolio and the Vanguard REIT ETF (NYSEARCA:VNQ).

Vanguard REIT ETF - Investment Synopsis

The Vanguard REIT ETF invests in stocks issued by real estate investment trusts (REITs), companies that purchase office buildings, hotels, and other real property. The goal of VNQ is to closely track the return of the MSCI U.S. REIT Index, a gauge of real estate stocks. VNQ offers high potential for investment income and some growth. VNQ is appropriate for helping diversify the risks of stocks and bonds in a portfolio.

Long term performance of VNQ compared to the S&P 500

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Source: Yahoo Finance (2/14/2016)

As the chart above shows, since July 2004, VNQ and the S&P 500 have tracked each other relatively closely, VNQ, the blue line is up 44% compared to the S&P 500, the red line, up 65%. The chart does not include dividends, which would improve the relative performance of VNQ versus the S&P 500.

5 Year performance of VNQ compared to the S&P 500

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Source: Yahoo Finance (2/14/2016)

More recently, over the last 5 year period, VNQ, the blue line is up 23% compared to the S&P 500, the red line is up 39%. Again, the chart does not include dividends, which would improve the relative performance of VNQ versus the S&P 500.

When setting up a Core ETF portfolio and making an initial allocation, an investor may want to consider both the relative historical performance and the expected future performance of REITs compared to the other sectors covered in the Core ETF portfolio.

Performance of VNQ

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Source: Vanguard (as of 1/31/2016)

Since bottoming in 2009, VNQ has performed very well. Since I am not very familiar with the real estate sector, I would like to do some more research to try to better understand where we are in the real estate cycle before making an initial investment in this sector.

Equity characteristics of VNQ vs the S&P 500

Vanguard REIT ETF

Vanguard S&P 500 ETF (NYSEARCA:VOO)

Number of stocks

152

507

Median market cap

$11.1 billion

$79.6 billion

Price/earnings ratio

35.3

19.3

Price/book ratio

2.3

2.6

Return on equity

7.0%

18.5%

Earnings growth rate

18.9%

9.3%

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Source: Vanguard (as of 1/31/2016)

I have not invested in REITs in the past. What stands out to me is the higher price/earnings ratio, which I would expect is due to the impact of much higher depreciation expenses for REITs than the S&P 500.

Equity sector diversification

Source: Vanguard (as of 1/31/2016)

VNQ's largest holdings are in retail REITs followed by residential.

ETFs in the U.S. broad REIT category

Symbol

Fund Name

AUM ($MM)

Expense Ratio

VNQ

Vanguard REIT Index ETF

25,268

0.12%

IYR

iShares U.S. Real Estate ETF

3,843

0.43%

ICF

iShares Cohen & Steers REIT ETF

3,227

0.35%

RWR

SPDR Dow Jones REIT ETF

3,001

0.25%

SCHH

Schwab U.S. REIT ETF

1,705

0.07%

FRI

First Trust S&P REIT Index ETF

201

0.50%

KBWY

PowerShares KBW Premium Yield Equity REIT Portfolio ETF

95

0.35%

FTY

iShares Real Estate 50 ETF

70

0.48%

PSR

PowerShares Active U.S. Real Estate ETF

48

0.80%

FREL

Fidelity MSCI Real Estate Index ETF

43

0.12%

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Source: Seeking Alpha (as of 2/14/2016)

Above is a list of the top 10 U.S. broad REIT ETFs, listed by assets under management (AUM). As the table shows, VNQ is the largest U.S. broad REIT ETF by AUM and it is tied for the second lowest expense ratio after the Schwab U.S. REIT ETF. For those that want to do further research, additional detail on these ETFs is available on Seeking Alpha's ETF Hub.

Expenses and dividend yield

VNQ's expense ratio is 0.12%, this is well below the average expense ratio of similar funds. Of the top ten U.S. broad REIT ETFs listed above, only the Schwab U.S. REIT ETF has a lower expense ratio.

The current unadjusted effective yield is 3.99% as of 01/31/2016, which is based on the full amount of REIT distributions (dividend income, as well as return of capital and capital gain). The current adjusted effective yield is 2.70% as of 01/31/2016. The adjusted yield reflects a reduction in the income included in the yield based on the average return of capital and capital gain distributions received from the fund's REIT investments for the past 2 calendar years. (These percentages are 31.44% for 2014 and 30.29% for 2013.)

Conclusion

Since bottoming in 2009, VNQ has performed very well. Since I am not very familiar with the real estate sector, I would like to do some more research to try to better understand where we are in the real estate cycle before making an initial investment in this sector for my portfolio. I do believe that VNQ is a good option for the REIT portion of an investor's core ETF portfolio and will likely consider it again when I believe I understand better where we are in the real estate cycle and believe it is a good time to invest in this sector.

Addendum

Seeking Alpha's Investment Guide Core ETF Portfolio

ETF Ticker

Fund Name

Fund Description

Expense Ratio

VOO

Vanguard S&P 500 ETF

Large cap U.S. stocks

0.05%

IJH

iShares Core S&P Mid Cap ETF

Mid cap U.S. stocks

0.12%

VTWO

Vanguard Russell 2000 ETF

Small cap U.S. stocks

0.15%

IEFA

iShares Core MSCI EAFE ETF

Multi cap foreign developed market stocks

0.12%

IEMG

iShares Core MSCI Emerging Markets ETF

Multi cap emerging market stocks

0.18%

LQD

iShares iBoxx $ Investment Grade Corporate Bond ETF

U.S. investment grade corporate bonds

0.15%

PLW

PowerShares 1-30 Laddered Treasury Portfolio ETF

U.S. Treasuries

0.25%

SCHP

Schwab U.S. TIPS ETF

U.S. TIPS

0.07%

VNQ

Vanguard REIT Index ETF

U.S. REITs

0.10%

DBC

PowerShares DB Commodity Index Tracking ETF

Broad commodities

0.85%

Click to enlarge

Simply Investing - Philosophy

Establishing a core portfolio in well-diversified, low expense ETFs, held for the long term, is a good idea for most all investors. The core of a small portfolio can start off as simple as one well diversified global ETF with a low expense ratio, like the Vanguard Total World Stock ETF (NYSEARCA:VT). Typically, as the portfolio grows, the core of the portfolio would include exposure to the ten asset classes listed above.

There are four steps needed to set up an efficient investment plan. The decisions and actions required to set up the plan and purchase the ETFs can be done in about 4 hours (see the further reading section below for more details):

  1. Decide on an asset allocation plan among the ETFs in the core portfolio.
  2. Open an online brokerage account with a linked online bank account.
  3. Determine if you will invest all your investment funds at once or over a period of time.
  4. Determine which investments to buy in your taxable and tax deferred accounts.

The core ETF portfolio outlined above, after tax, should significantly outperform either individual stock picking or a portfolio managed by a financial advisor. Over the typical investors time horizon of 40+ years the expected advantage of this core ETF portfolio is staggering.

Investors that enjoy the investment analysis process and are willing to spend the time to analyze and invest in individual stocks or sectors can still do this. I believe, the majority of these investors should still set up a core ETF portfolio, but can allocate a small, fixed percentage of their portfolio to "edge" positions, which offer additional risk and opportunity.

Further reading

ETF Investing Guide - Written by Seeking Alpha's Founder in 2006 is a great guide for setting up a portfolio of ETFs.

Set Up A Core ETF Portfolio Now - Describes the four steps required to implement the suggestions in the ETF Investing Guide. The ETF Investing Guide is made up of 54 articles and takes some time to read and assimilate the information. This article condenses the information from the guide down to four steps that can be completed to set up a core ETF portfolio in around four hours.

Disclosure: I am/we are long VT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.