VNQ: 3 Reasons Why VNQ Is King Of The REIT ETFs

Feb. 21, 2022 7:46 AM ETVanguard Real Estate ETF (VNQ)USRT, IYR, SCHH, XLRE, RWR, FRI5 Comments
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Summary

  • VNQ is a widely diversified, real estate investment trust focused ETF managed by Vanguard.
  • The fund is the largest real estate ETF by assets under management.
  • We highlight three key reasons why VNQ is the most popular REIT ETF.

Real estate investing concept. American dollar, cash or housing. Keys close-up

MaslovMax/iStock via Getty Images

The Vanguard Real Estate ETF (NYSEARCA:VNQ) is a popular, REIT ETF that has provided diversified exposure to United States REITs for over a decade. Investors looking to access real assets have a variety of investment options. Possibly the most well-known is the traditional route of buying assets and renting them to tenants. However, as many articles on SA cover, this avenue is time intensive, risky, and often limits investors to residential assets or lower level commercial properties. Investors looking to access institutional quality real estate have fewer options.

Real estate investment trusts are publicly traded companies which invest directly in high quality real estate. Often times, these are premier assets in some of the strongest markets across the country. However, there are hundreds of different publicly traded REITs and some are stronger than others. As a result, investors much choose where to place capital which in and of itself can be treacherous. However, modern alternatives exist which eliminate selection risk altogether. Investors can buy REIT focused funds which are actively or passively managed offering further diversification. With two layers of diversification, this option is a safer way to invest in real estate than direct ownership.

VNQ invests in stock issued by domestic Real Estate Investment Trusts, tracking the MSCI US Investable Market Real Estate 20/50 Index. There are many REIT ETFs available for investors and their underlying index is often the defining difference between options. VNQ’s index takes the widest approach of all competitors, encompassing the overwhelming majority of what would be considered the real estate market, which extends beyond only REITs.

“The MSCI US IMI Real Estate 25/50 Index is designed to capture the large, mid and small cap segments of the U.S. equity universe. All securities in the index are classified in the Real Estate sector as per the Global Industry Classification Standard (GICS®). The index also applies certain investment limits to help ensure diversification--limits that are imposed on regulated investment companies, or RICs, under the current US Internal Revenue Code.”

Source: MSCI

The index has 165 constituents and is broken down with the following industry weights.

Chart, aMSCI US IMI Real Estate 25/50 Index - Sub Industry Weights

MSCI

Being that VNQ is an index ETF, it will come as no surprise that the fund is similar in construction. The largest holdings are the same and the overall portfolio characteristics match closely.

VNQ equity characteristics

Vanguard

The recipe has been successful with VNQ providing excellent, market beating returns over the past year. These returns have been broadly powered by a strong economy and inflation which have acted as tailwinds for asset values and market rents across geographies and asset classes.

VNQ vs VOO return
Data by YCharts

Investors who shop around will note that the portfolio is similar to other competing REIT funds. This is true and the reason why many similar ETFs have comparable long term performance. With a similar portfolio, investors looking to limit risk may wonder which ETF is the superior option. We will outline three specific reasons why VNQ is a strong choice.

Reason #1: Liquidity

As we mentioned, VNQ seeks to track the MSCI US IMI Real Estate 25/50 Index. The fund is large, managing over $91.5 billion in total assets. In fact, VNQ is the largest REIT ETF by assets, outpacing other options from Schwab, BlackRock, and other competitors

VNQ vs peers AUM
Data by YCharts

The fund also boasts impressive trading volumes, again outpacing competitors by a significant margin. Average daily volumes are supportive of large trades for investors looking to move large amounts of capital. Some competitors do not offer the same depth and thin trading volume can be problematic for a variety of reasons. One reason is wider bid ask spreads. Although usually immaterial, low volume can cause spreads to expand with significant impact as scale increases. Pennies per share become more meaningful when moving thousands of shares. Additionally, low volume can lead to deviations in net asset value. VNQ is again a leader in this category as the fund perpetually trades close to NAV.

The index is market cap weighted meaning larger companies receive a larger allocation. This solves an issue that often accompanies scale for a fund. As capital flows into VNQ, the fund is required to purchase shares of constituents accordingly. This can be problematic if the underlying company is far smaller than the fund. Fortunately, VNQ’s focus on larger REITs means liquidity of underlying holdings is not an issue. As it stands today, the largest position in the fund is Prologis at 8.73%. Prologis is the world’s largest industrial REIT, owning and operating a material portion of the global supply chain. Other notable positions include data center REIT Equinix (EQIX) and mall operator Simon Property Group (SPG).

The fund casts a wide net, providing exposure to all equity REITS in the United States, weighting more heavily towards the largest capitalization companies. VNQ does not invest in mortgage REITs. Although focused on Real Estate, the fund provides exposure to a variety of sectors including specialized REITs (24.4%), Residential REITs (19.6%), and Industrial REITs (13.8%).

Reason #2: Options

VNQ launched in 2004, operating successfully and distributing dividends nicely ever since. The fund has performed well, tracking its benchmark over all time periods. The track record is just one reason why VNQ has become such a popular option for REIT investors. For years, the fund was one of the only REIT focused funds and has accordingly entrenched itself as the most popular option. Along with this popularity has come certain benefits.

One such benefit is the availability of options for shareholders. Derivatives are generally reserved for sophisticated investors, but those willing to take the risk will likely choose VNQ. While volumes are still limited in comparison to other tickers, VNQ currently has the deepest and most expansive options chain of any real estate fund. VNQ’s options are available in next-month and quarterly expirations with sufficient open interest for many investors looking to trade calls or puts. Investors looking to speculate will find VNQ has the best availability and volumes of any REIT ETF.

Reason #3: Expense Ratio

Put simply, VNQ offers broad exposure to the U.S. real estate market. The fund is well managed and weighted towards the largest, most established companies in the real estate sector. Even better, each underlying holding owns hundreds or thousands of individual properties, meaning risk is thoroughly reduced. The result has been strong performance, especially over the past year as inflation kicks up.

VNQ is managed by Vanguard, the world’s second largest fund manager in terms of assets under management. Today, the firm manages over $7 trillion in client assets advising to individuals and institutions across the entire spectrum.

As is traditional with Vanguard funds, the Real Estate ETF has an extremely competitive management fee of only 0.12%. For every $1000 invested in the fund, you can expect to pay Vanguard $1.20 annually to manage the assets. In another scenario, $10,000 invested over the course of ten years will cost you an estimated $283 in total management fees.

VNQ expenses

Vanguard

Source: Vanguard

Vanguard’s fee is also highly competitive among the broader competitive landscape. In a quick comparison, we will see VNQ is among the most competitive of large REIT ETFs. The management fee is only bested by options from BlackRock and Schwab, both of which are considerably newer than VNQ. It would not be surprising if we saw a reduction in VNQ’s fee to become more competitive, but that is pure speculation and possibly wishful thinking.

Fund Name

Expense Ratio

USRT

0.08%

VNQ

0.12%

IYR

0.41%

SCHH

0.07%

XLRE

0.12%

RWR

0.25%

FRI

0.50%

Source: Author Using Data From Seeking Alpha

A best in class expense ratio from one of the world’s largest asset managers creates a compelling opportunity.

Conclusion

VNQ is an excellent option for investors looking to access a broad real estate opportunity. With over a hundred different holdings, the fund is well diversified. We would be remiss to cover a REIT fund without providing some detail on the dividend. VNQ offers a yield of 2.91% based on current share prices. This yield dramatically outpaces the broader equity market, making it an excellent choice for income investors.

VNQ vs VOO vs BND dividend yield
Data by YCharts

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While VNQ’s yield has compressed over the past several years, there are tailwinds which could help the fund’s distribution. As inflation kicks up, rents across the country are skyrocketing, Accordingly, most REITs will see a direct benefit through increasing. A rising dividend becomes increasingly attractive during an inflationary period as time eats into purchasing power.

In contrast to owning individual real assets, VNQ offers a scalable, liquid opportunity to invest directly in the equity of public REITs. Furthermore, shareholders will benefit from professional management and legal advantages that traditional real estate do not offer. REITs may just prove to be a superior choice for real estate investors if simplicity is an important consideration. The secular advantages of VNQ make it a strong choice among the broader competitive landscape.

This article was written by

Obsidian Limited profile picture
1.31K Followers
Obsidian Limited provides investors with income focused insights and research. We identify and cover opportunities across asset classes with a focus on appreciating cash flow.

Disclosure: I/we have a beneficial long position in the shares of VNQ either through stock ownership, options, or other derivatives. 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.

Additional disclosure: This article is not investment advice. Research provided in this article is supportive of your own thorough and complete due diligence. Please consult your investment advisor on opportunities presented herein.

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