I hold the iShares S&P/TSX Capped REIT Index ETF (XRE) and it has been doing well. I would like to increase my exposure to Canadian REITs. Should I buy more XRE or diversify and purchase another ETF such as VRE or ZRE?
Real estate investment trusts own income-producing assets such as shopping centres, offices, industrial buildings, apartments or – in many cases – a mix of property types. The beauty of REIT ETFs is that they give you exposure to a basket of REITs and a diverse portfolio of properties across the country with a single investment. And you’ll never have to bang on anyone’s door to collect the rent – the “cheques” just land in your brokerage account every month.
Assuming you don’t already have ample REIT exposure – I usually aim for about 10 per cent to 15 per cent of my equity portfolio – diversifying your REIT holdings is probably a good call in your case.
Why not just add more to your existing XRE position? Well, XRE’s top four holdings – Canadian Apartment Properties REIT (CAR.UN), RioCan REIT (REI.UN), H&R REIT (HR.UN) and Allied Properties REIT (AP.UN) – account for about 48 per cent of the fund’s assets. That’s a hefty weighting in just four names.
Similarly, Vanguard’s FTSE Canadian Capped REIT Index ETF (VRE) has roughly a 43-per-cent weighting in the same four REITs, so VRE wouldn’t be my first choice if you’re looking to diversify. Even though XRE and VRE track different indexes, both benchmarks weight their constituents based on market capitalization, which explains the overlap.
The good news is that not all REIT ETFs use market-cap weighting. The BMO Equal Weight REITs Index ETF (ZRE) follows – you guessed it – an equal-weight methodology that prevents any REIT from having outsized influence, for good or bad, over the fund’s returns. As of Sept. 5, ZRE’s largest holding was Summit Industrial Income REIT (SMU.UN), at about 5 per cent, and the smallest was SmartCentres REIT (SRU.UN), at about 4 per cent. Given its weighting system, ZRE might be a good choice if your goal is to diversify.
In other respects, XRE and ZRE are similar. Both have a management expense ratio of 0.61 per cent and yield about 4.1 per cent, based on cash distributions paid over the past 12 months. As for VRE, it has a lower MER of 0.39 per cent (which is a good thing), but its yield is also lower, at 3.3 per cent (which is a drawback if you are primarily seeking income). VRE’s lower yield reflects the inclusion of several real estate corporations, which do not use a REIT structure and generally pay out less cash than REITs.
Still another option is the CI First Asset Canadian REIT ETF (RIT). Unlike the other ETFs discussed here, RIT does not track a REIT index but is actively managed. This is reflected in RIT’s higher MER of 0.9 per cent. Is the extra cost for active management worth it? Well, RIT’s annualized total return (assuming all distributions were reinvested) for the three years to Aug. 31 was about 12.1 per cent, which slightly trailed ZRE’s total return of 13.4 per cent over the same period. Both of these ETFs topped XRE’s annualized three-year total return of 11.4 per cent and VRE’s return of about 10.1 per cent. These are backward-looking numbers, and there are no guarantees that RIT and ZRE will continue to outperform.
Finally, depending on your comfort level and how much capital you have available, you may wish to consider owning individual REITs instead of REIT ETFs. You’ll pay brokerage commissions on your initial (and subsequent) purchases, but you will eliminate the MER that REIT ETFs charge on a continuing basis. Buying individual securities is not for everyone, but it will slash your costs and could improve your returns. The MERs on REIT ETFs aren’t egregious, but they’re significantly higher than the MERs on broad index-tracking ETFs.
All of that said, the REIT ETFs discussed here all give you diversified exposure to real estate at a reasonable cost. More important than the subtle differences in MERs, yields and holdings of each ETF is the behaviour of the person who owns them. Real estate is a cyclical business, and it has benefited in recent years from a strong tailwind of falling interest rates. If interest rates rise, the economy stumbles or REITs have difficulty accessing capital, REIT unit prices will likely suffer in the short run. But real estate has been a great long-term investment, and holding it through good times and bad – and collecting the attractive distributions that REITs offer – is probably the best strategy. So, if you’re going to add to your REIT position, keep that in mind.
E-mail your questions to jheinzl@globeandmail.com.
John Heinzl