Eight US Real Estate ETFs

US real estate ETFs are a bellwether asset class these days. They have been tossed about by changes in bank credit and interest rates and remain an important hedge against inflation. We put US real estate ETFs under the microscope to identify the strongest candidates for various portfolio uses.

The first thing to emphasize is that no real estate ETF is exposed to single family housing, which is causing so much grief to individual Americans. With the recent withdrawal of the Adelante Shares line of real estate ETFs, the field has shrunk considerably. There are now five broad or large cap ETFs suitable as a core holding:

• Vanguard REIT (VNQ); Expense Ratio: 0.12%
• SPDR Dow Jones Wilshire REIT (RWR); ER: 0.25%
• iShares Cohen & Steers Realty Majors (ICF); ER: 0.35%
• iShares FTSE NAREIT Real Estate 50 (FTY); ER: 0.48%
• First Trust S&P REIT (FRI); ER: 0.5%

Most of these ETFs contain about 100 firms, but ICF has 30 holdings and FTY around 50. All offer diversification into office/industrial, residential apartments, storage, hotels, etc. The indexes behind these products are all modern, straightforward market cap weighted baskets run by top firms.

Holdings of these five ETFs are quite similar. For instance, nine of the top ten holdings of VNQ, RWR and ICF are the same, and the top three REIT holdings occur in the same order: 1) Simon Property Group, 2) Prologis and 3) Vornado Realty. VNQ, RWR and ICF hold 17.7% of their assets in identical amounts of these three REITs, and that is just the first three on the list . Investors can assume that 50% of all broad-based REIT ETFs are absolutely identical. If an investor is looking for one ETF to outperform another, it must do so with only half of its assets.

Fees are all over the map. Vanguard as usual has set the bar low. It charges from .12% to .38% less than competitors.

What might justify paying higher fees? RWR is so close in cost to VNQ that mere convenience or familiarity is sufficient justification. For other ETFs a reasonable justification might be average holding size. Investors may wish to take advantage of disparities in valuations of large vs. small firms.

Here we were surprised. We expected ICF to have larger firms due to its fewer holdings, but the reverse was true. VNQ's median market cap is $5.9 Billion vs. ICF's $4.9 Billion. In any case it's not enough of a difference to meaningfully overweight by cap size. Broad comparison is made difficult by the different metrics disclosed by the various providers. We conclude that for most investors VNQ is the superior choice, with RWR an excellent alternative.

US real estate is a vast field, and it deserves ETFs for at least some of the more sizeable sub-indexes. It may be useful for some investors, for instance, to emphasize commercial over residential, office over apartments, etc. There are currently three niche US ETFs, of which the first two are true baskets of REITs and the third a completely different animal.

• iShares FTSE NAREIT Industrial/Office ETF (FIO): Expense Ratio: 0.48%
• iShares FTSE NAREIT Residential ETF (REZ) ER: 0.48%
• iShares FTSE NAREIT Mortgage ETF (REM) ER: 0.48%

FIO contains two dozen US REITs with heavy industrial and office holdings. It holds almost 35% in only two firms, so it does not offer great diversification. It is ideal for overweighting in small amounts or for trading, however, and its fees are reasonable for a niche product. Likewise for REZ, which is made up mostly of apartment building REITs. A very different creature is REM, which is composed of mortgage lenders, not REITs, and should be handled with extreme care until the housing crisis is over. Most investors wisely shunned it in 2007, but someday it may be an intriguing play for bottom fishers.

Investors are well served by a variety of aggressively priced real estate ETFs for core portfolio positions and by a few fairly priced niche products.