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Don't Pay Up to Play REITs

The single most important thing to focus on when investing in a REIT ETF is the expense ratio, and Vanguard REIT Index is about as low as they go.


Bob Goldsborough: For inexpensive exposure to the United States real estate investment trust industry--or REIT industry--one ETF that investors can consider is Vanguard REIT Index ETF (VNQ).

VNQ is far and away the largest REIT ETF, and it holds companies that are known as equity REITs, which own office buildings, strip malls, and hotels. They own and manage these real estate properties, and then they collect rent.

To qualify as a REIT, a firm must pay out 90% of its taxable income to its shareholders in the form of dividends. As a result, in a low-interest-rate environment like the one we are in, REITs have shown themselves to be very popular with investors seeking income options.

VNQ's yield right now is 4.1%, which is about two percentage points higher than that of the S&P 500 Index. Because most REIT ETF portfolios are very similar, the single most important thing to focus on when investing in a REIT ETF is the expense ratio. VNQ charges an expense ratio of 10 basis points, making it one of the lowest-priced ETF options available.

A major consideration when investing in REITs is interest rate. When investors believe that interest rates are going to go up, REITs tend to fall under pressure. The reason is that, as interest rates rise, REITs' interest expense payments go up, leaving REIT firms with less cash flow available to pay out to its shareholders for dividend.

For investors who are concerned about interest rates or who believe interest rates are going up soon, the REIT sector is probably one to avoid. However, for investors who aren't concerned about that or who believe that today's low-rate environment is here to stay, we think VNQ is a really solid investment option.

Robert Goldsborough does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.