REIT ETF? Or REIT Investment Trusts?

by Mike Holman

I’ve been pondering buying some REITs in order to increase the real estate allocation of my portfolio which is currently at zero. Several options have popped up:

  1. XRE – iShares REIT ETF which is made up of Canadian REITs.
  2. Buying just the top REIT (RioCan) in XRE.
  3. Buying the top three REITs in XRE.
  4. Buying the top eight REITs in XRE.
  5. American REITs most notably Vanguard REIT ETF (VNQ).

Today I will look at the first three options – feel free to suggest any others.

XRE – iShares Canadian REIT Sector Fund Index is my first choice for REITs. It replicates the S&P/TSX Capped REIT Index and fits very well with my (mostly) passive investment choice. The only problem with this particular ETF is that it has a high MER of 0.55%. Now 0.55% is not totally outrageous but it seems a bit high considering that you can buy the top three REITs in the index and get 50% of the market capitalization of XRE. Another option is to buy the top eight REITs and get 85% of the capitalization of XRE.

The amount I’m planning to own for REITs is about $20,000 which is about 8% of our portfolio. For the purposes of this comparison I’ll assume a 10 year investment time horizon.

  1. Paying 0.55% management fee of XRE per year will result in $110 per year in fees.
  2. Buying just RioCan (REI-UN.TO) will result in a $4.95 purchase fee which works out to $0.50 per year in fees. Problem is that this stock only covers 25% of the REIT index so diversification might not be good enough.
  3. Buying the top three Reits (RioCan, H&R, Can) will result in about $1.50 in fees per year. This will give me about 50% of the capitalization of the index which isn’t bad.
  4. Buying the top eight Reits (RioCan, H&R, Can, Boardwalk, Calloway, Chartwell Seniors Housing, Canada Apartment Properties, Primaris Retail) will result in about $4.00 in fees per year. This will give me about 85% of the capitalization of the index which is pretty darn good.

When I look at the numbers it’s pretty obvious that as long as I don’t care about following the REIT index too closely, buying XRE is a bit of a ripoff. I could probably buy every single REIT in the index and still save money on it’s MER. Buying the top REIT, the top three and the top eight are all pretty much the same cost given that they are all chump change. I think that the extra diversification of buying the top eight is worth the extra couple of bucks per year. With 85% of the index covered, that’s good enough for me. I’ve ignored rebalancing costs but since I’m not too concerned about following the index exactly, I don’t think those will be very much.

I still have to consider US REITs but that will be for another day.

Conclusion

For the amount of REITs I want to buy ($20k) and my trading fees ($4.95) I think that buying the top eight REITs in the REIT index will give me adequate diversification (85% of index) and low costs ($4 per year).

If anyone has any thoughts on my analysis then I’d love to hear them.

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{ 23 comments… read them below or add one }

1 MillionDollarJourney

Mike, if the index is weighted by market cap and you buy all 8 stocks, how are you going to weigh them? 8 stocks split evenly with the $20k?

2 Four Pillars

MDJ – good question.

I think weighting them by market cap (of the top 85%) is how I would do it.

For example if the top REIT is 20% of the entire index then it will be 23.5% of my 8-reit index (20/85).

I’m not too concerned about getting it exact and I don’t think I would rebalance very often either.

Mike

3 Leslie

I’d be interested in your take on the perspective that your investment in your house should be taken into consideration when balancing the asset mix of your portfolio. A portfolio may, for example, include bonds, ETFs, mutual funds etc., real property (your home), and cash in savings. For many people their home is a significant chunk of their networth.

4 Four Pillars

Leslie, I think that questions warrants a post of it’s own. As well I’d be interested to hear your thoughts on this topic.

I guess my short answer is that I don’t count my house as part of my portfolio as real estate and I don’t count paying off the mortgage as buying fixed income. I completely understand why some people do but I don’t.

5 zwz

I think should you count the house as an investment is depended on what is your plan of the house. If the only purpose for the house is living, never will you move so that you never plan to sell it, then it might not being counted as investment.

However, even you have decided to live in current house for your whole life. If you have kids, I think you’d better count it as an investment.

For me, I count my current house also as an investment. As the result, I will never consider a REIT in my portfolio. Just too much.

6 Canadian Capitalist

My personal view is that a personal residence is just that – a home, not an investment holding. I also think REITs have an important role in a portfolio because they provide “equity-like” returns and dance to a different tune than the equity market.

Mike, personally I own only RioCan for my REIT exposure, though I might switch to 50% REI.un and 50% HR.un at some point. My REIT exposure is 5% though David Swensen suggests going as high as 20%. I don’t plan on adding US or other REITs at present.

7 Four Pillars

Hi Zwz – thanks for the comment. Why do you think that having kids makes a difference in whether you count your house in your portfolio?

CC – I certainly considered just going with RioCan but I like the idea of having more coverage of the index.

By the way I’ve never heard of Astrix so I completely missed joke yesterday until Mr. Cheap explained it to me. 🙂

8 Leslie

Counting a house as part of your portfolio may not be appropriate as it does not fit the definition of an asset. You’re not likely to manage it like a traditional asset such as when rebalancing (would you move to a smaller house if your ‘portfolio’ was too heavy in real estate?). Except as an academic exercise in calculating net worth, or adding up your assets to prepare a will, IMHO it should be set aside.

The sector is down now so a good time to buy; I’m with CC to buy REI.UN & H&R–no sense to pay MERs on ETF when these are the heavies–but max weight to 5% of your portfolio. Just my opinion.

9 FinancialJungle

Having 8 REITs (or even 4) is an overkill. If you must have 8 REITs, then you ought to have 8 financials, 8 utilities, 8 energy stocks, 8 materials, 8 retails, 8 industrial, … Oh boy!

Pretty soon, you’ll have 100 direct ownerships.

Even having just one offers instant diversification across Canada. To put that into perspective, some landlords actually leverage 5 times their down payment to buy one apartment building.

BTW, I’m curious why you said “I dont count paying off the mortgage as buying fixed income. I completely understand why some people do but I dont.”

Paying off the mortgage isn’t exactly like buying fixed income; it’s better!

10 Four Pillars

FJ – I’ve been expecting your arrival… 🙂

How do you turn 8 reits into 100?

My logic for picking these reits was from taking the top of the index which is more or less a very passive (and lazy) approach.

Why do you think that having 8 reits is overkill? Are they all the same?

I guess this might lead me to actually look a bit closer at these reits which I haven’t done.

paying down Mortgage <> fixed income:

for one thing, I use fixed income to help smooth out the variations of the equity markets. Although in theory paying down your mortgage could accomplish the same thing – since I don’t count my mortgage or house in my portfolio then it doesn’t work for me.

I do however put paying down the mortage ahead of any other type of investing/savings.

11 FinancialJungle

😀 I’ve been working a lot of overtime lately. Better late than never…

I meant to say 100 direct ownership in various sectors including financial, energy, etc…

12 FinancialJungle

I’d like to add that while more REITs is more diversified than a few, but the benefit diminishes as you move beyond 2 or 3. REITs require a lot of paper work to track as well: return of capital vs dividends vs income, and adjusted cost base. Having 2 or 3 aren’t so bad, but 8 can be a nightmare. Who wants to do all the paper work for a few bucks per month of income? That’s what you’re getting for the bottom 5 or so REITs if you’re weighing them according to market values.

13 Four Pillars

FJ – glad you’re here!

These REITs will only be in my rrsp so paperwork will not be an issue.

Regardless your point is well taken and I will do some analysis on these reits.

14 Betty

Found this site tonight and found the topic very interesting. I was going to add a REIT to my rrsp and was leaning toward the ETF. You make a convincing argument towards buying individual ones. I am familiar with Riocan but not Rei.un or Hr.un. Guess I will have to do some homework.

15 Four Pillars

Betty – thanks for visiting.

It’s a tough call since it’s more work to buy individual REITs and I’m not sure how much overlap there will be. I’m going to do some more research and will post again.

Mike

16 Andy

Mike: You might also want to look at which REITS will survive after January 1 2011.
My understanding is that Chartwell does not qualify as a REIT after 2010 [two years from now]
I think this is important because a person may buy a REIT now with 10% yield but it may only be 5% after 2010.
I have begun to write to the REITS and I asked them “Do you qualify as a REIT after 2010?” None of them qualify of those that responded so far. Not even Rei.un. Rei.um said they are working on qualifying.Andy

17 Four Pillars

Thanks Andy – plesae let me know what you find out about the various REITs – that would make a great post!

18 Nawar Alsaadi

H&R Reit (HR.UN) offer excellent value here

Upon doing further DD, I have purchased significant position in H&R this morning, I believe the unit price already reflect a possible 50% cut in the payout, while the current market cap gives ample protection in case of asset sales in a depressed market.

Thus getting an average of 14%/15% dividend (assuming a 50% cut), while waiting for the equity to appreciate back to book value $15+ seems like an excellent deal.

Finally, it is worth noting that 50% of H&R loans are none-recourse financing, thus in an event of an issue of those loans, the risk will be limited to the underlying property and not the whole company.

any comments welcome!,

Regards,
Nawar

19 Jordan

Mike have you posted a follow up to this idea of unbundling XRE? You and CC make a good argument and I’m thinking of doing the same thing, but I’d like to know if you ended up doing it, what % of the index you’ve decided to use or have any new insight into REITs. Thanks!

20 Paul

I am thinking of redirecting some of my RRSP investments from equity to REITs through a self directed RRSP. I am 40 and have about $60,000 in RRSPs – after they declined over 25% last year.

I realize there is no loss until I cash in, but would you suggest redirecting some to REITs given that most REITs seemed to have a tough year as well? What % would you recommend?

Also curious as to how many readers are continuing to invest through a monthly plan or just a lump sum (wait and see)?

Thanks!

21 Four Pillars

Paul – I don’t give specific investment advice.

I would suggest that you take a look at your asset allocation and decide how much reits you want to have and then buy/sell accordingly.

As for my asset allocation I have given serious thought to convert some of the 20% fixed income to equities over the next little while.

22 AC

Buying a real estate investment trust etf maybe a simple way to get exposure to a basket of REITs if thats all an investor wants.

However, there is a reason why most REITs are yielding greater than 10% and some as much as 30%; namely perceived risk.

More often than not, when a REIT has financial difficulty, it will be the unit holders distribution that will be cut or eliminated. The effect of which will not only negatively affect the distribution but often it will severely affect the REITs price per unit, resulting in a double whammy.

Many REITs are paying in excess of 100% of Distributable Income including by our analysis RioCan REIT, Canadas largest REIT. Others have debentures and mortgages coming due without much hope of replacing and all are at least dealing with a contracting economy and all its related manifestations.

Buying even an eft without proper due diligence is simply reckless.

AC
REITinvestor.ca

23 NoMoreTax

Nice article. I was reading this article and was wondering what the tax implications are if the investment is in RSP?

http://www.canadiancapitalist.com/how-withholding-taxes-affect-the-choice-of-international-investments/

Thanks,

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