Investors Put A Down Payment On High-Yielding Real Estate ETFs

by on April 11, 2011 | ETFs Mentioned:

To say that the current investment landscape is complex would be quite the understatement. Recent weeks have seen environmental, humanitarian, and economic crises break out in Japan, with the aftershocks rippling throughout the global economy. Moving across the globe, the Libyan Crisis has dominated headlines for quite some time now, as a series of revolutions spreading across the Middle East came to a head in this volatile nation. Now that key oil production in Libya has come to a standstill, the price of crude is skyrocketing, jumping to over $113 per barrel last week.

While equity markets are uncertain, the appeal of fixed income has been dulled by a prolonged stretch of record low interest rates. Though the ECB has finally pushed rates higher, yields throughout the developed world remain anemic. This combination has brought renewed interest to dividend-paying equities, an option for investors looking to dial back equity risk a bit without taking on duration risk from fixed income securities [see also Five More iShares ETFs Now Available Commission Free].

Many investors are quick to overlook the strength of a dividend, as yields sometimes seem too minuscule to make a significant difference on a portfolio. On the contrary, even a yield as low as 2% can have a major impact on investments, as a portfolio with a baseline investment of $100,000, earning an average 2% annually off of dividends, will appreciate to approximately $150,000 in 20 years, assuming the gains are re-invested and no appreciation in stock price. In fact, a recent study conducted by Standard & Poor’s found that dividend components were responsible for 44% of the total return in the last 80 years of the index’s history [see ETF Dividend Ideas For 2011].

While there are a number of ETFs that seek to replicate dividend-weighted indexes or that screen component companies by dividend yield, there are other options for capturing a juicy payout. Enter real-estate funds that invest exclusively in real estate investment trusts (REITs), corporate entities that are eligible for tax-friendly treatment if they return a significant portion of income back to the shareholders–typically in the form of a dividend. As with any high yielding investment, these investment trusts come with their fair share of downsides but can often offer hefty yields, sometimes in excess of 15% for some component companies.

There are some risks to REITs in the current environment; with interest rates at an all-time low, they could be in trouble as a rise in rates would make it harder for these corporations to pay back the hefty debt burdens. Also, during the collapse of residential and commercial real estate markets in 2008, some of these funds lost huge chunks of their share prices–in some cases up to 70%. Many have still not returned to pre-recession levels [see also Time For A Real Estate ETF?].

With broad real estate markets sitting at a low point, and numerous REITs offering strong yields, now may be a good time to buy into their return strategy if you believe that commercial real estate markets have room for improvement as unemployment declines and interest rates will stay put for the near future. Below, we outline three high-yielding REIT-based ETFs for investors seeking strong returns in a yield-starved environment:

iShares FTSE NAREIT Mortgage REITs Index Fund (REM)

This ETF tracks an index which measures the performance of the residential and commercial real estate, mortgage finance, and savings associations sectors of the U.S. equity market. This fund represents a small cap play on the REIT market, as over 75% of its assets lie in securities that are classified as mid cap or smaller. Some of the top holdings of this fund include Annaly Capital Management (23%), New York Community Bancorp (6.5%), and Redwood Trust (2.3%). From a performance standpoint, this fund has had a rough year, losing close to 4%. But from a yield perspective, REM’s return is tough to match; the 30-day SEC yield is north of 10.3% and the 12-month yield at the end of the first quarter was a healthy 9.7% [see also How To Find The Right Dividend ETF].

Vanguard REIT ETF (VNQ)

VNQ seeks to replicate the performance of the MSCI US REIT Index, which is a benchmark of U.S. property trusts that covers about two-thirds of the value of the entire U.S. REIT market. The top holdings of this fund feature some of the most well-known names in the real estate industry, with Simon Property Group (9%), Public Storage (4.6%), and Vornado Realty Trust( 4.3%) all making appearances in the top holdings. This fund will offer more of a large cap play on the REIT sector, as it allocates over 75% of its assets to mid cap and large cap companies. So far, 2011 has been kind to large cap REIT firms, as this ETF has gained just under 4% in the first quarter of the year. On top of a solid performance, VNQ offers investors a healthy dividend payout of 3.3% annually. Because this fund is more dedicated to large-cap companies, it may present a strong play for investors looking for stable incomes through a lower-risk investment [see Three Real Estate ETFs To Watch If The IMF Is Right].

iShares FTSE EPRA/NAREIT Global Real Estate ex-U.S. Index Fund (IFGL)

This fund measures the performance of REITs listed in developed markets outside the US. For the most part, IFGL is focused on large and giant cap firms, giving investors a stable option to play real estate markets that exist beyond U.S. borders. From a country perspective, this ETF makes the largest allocations to Hong Kong (20%), Japan (16%), Australia (15%), and the UK (10%). IFGL’s 2011 performance has been decent up to this point, as it has returned roughly 2.4% to its investors. While a strong performance is nice, a steady income from dividends is even better, and IFGL is certainly a strong dividend play. This ETF has a 30-day SEC yield of about 2.6%, and has yielded 6.2% over the last 12 months [see also Examining International Dividend ETFs].

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Disclosure: No positions at time of writing.