Investing in Real Estate: REITs and ETFs

Can you trade real estate just like this guy trades securities? Of course, but let’s face it. Investing effectively in actual real estate is tough. A few reasons why are that real estate tends to be illiquid, and is usually rather expensive (at least in comparison to other financial instruments). There are a few ways to maintain exposure to the real estate sector without having to buy physical real estate. One way is to invest in a real estate investment trust (REIT), an example of a publicly traded REIT is Hersha Hospitality Trust (NYSE: HT). REIT’s invest their capital in real estate, and you can invest your money in the REIT by buying stock. By law REITs are required to return at least 90% of their operating profit to shareholders. Because of this the REIT will pay dividends.  Personally, I love investments that pay some sort of interest or dividend because it makes the investment feel more tangible. Another popular benefit is that you can reinvest your dividend. Essentially you were just able to purchase more stock for “free.” I put “free” in quotation marks because nothing in life is ever free, and also because the stock price may have depreciated and your initial investment may have lost money.

The major downside to investing in a REIT, however, also involves the dividend. Since 90% of the operating profits have to go back to the shareholders, the REIT can only reinvest 10% of its profit, creating slower than average growth. Another downside is that REITs are highly sensitive to interest rates. In general, REIT prices have an inverse relationship to interest rates. As interest rates rise, REIT prices typically fall, and vice versa. Even thought REIT ownership is typically lower leveraged, and therefore should be more insulated from interest rate changes at the property level that most forms of ownership, it is more about the inverse relationship that all equities have with interest rates (as yields get higher on debt, alternative investments like bonds become more attractive to investors)  In terms of an investment, though, REITs are a handy way to expose yourself to real estate, without having to actually invest in physical real estate.

Another way to expose your portfolio to the real estate sector, while maintaining liquidity is to invest in Real Estate ETFs.  I rarely trade anything but ETFs. Why? Investing in an exchange traded fund gives you the diversification of many stocks, with the liquidity that a mutual fund can’t provide. It is rather hard to create a diversified portfolio with limited savings, but this is a good way to do it. Let’s use NYSE: SPY as an example. SPY is a SPDR ETF, which tracks the S&P 500. Currently it is trading just north of $105. So for $105-ish/share I can get exposure to 500 stocks across 24 industries. Additionally, an added bonus of ETFs are that (for the most part) you can short them. Feel like betting against the market? Go for it.

A recent article in the Wall Street Journal mentioned that (at least according to the author) the commercial real estate market has bottomed out, causing him to feel confident in buying into real estate ETFs. There are those out there that are thinking that the worst is not over, but if you truly believe in the theory that the real estate market is cyclical, then buying in on the downslope or the upslope shouldn’t matter. Especially since prices are way down from their 5-year highs.

There are quite a few real estate ETFs and I will talk about a few of them here, but look for a top 10 in the future listing real estate ETFs. To introduce the idea of a leveraged ETF, I will use ProShares Ultra Real Estate ETF (NYSE: URE). This fund tracks the Dow Jones US Real Estate Index at a rate of 200% of the daily performance. If the index is up 4%, URE should be up around 8%. This can also create some large losses, but not as much as with Direxion’s Daily Real Estate Bear 3x (NYSE: DRV). One of a few inverse ETFs, this fund tracks -300% of the DJ US RE Index. I’m a big fan of Direxion, SPDR, ProShares, and the like, but care should be taken when dealing with these leveraged funds (note: care should be taken when making any investment). It should also be noted that historically the stock market gains value, so using an inverse ETF like DRV as a long term investment is generally considered poor strategy. There are even ETFs (like NYSE: VNQ) that invest solely in REITs, so you can have the added benefit of being able to invest in multiple REITs at once.

So you’re not Vornado Realty Trust (NYSE: VNO), Hersha Hospitality trust, or PREIT. You can’t go out and buy a diverse portfolio of property (if you can, we should talk. Email me at dmoquin@llenrock.com). But there are still ways you can still include real estate in your portfolio. Using REITs and ETFs are a great way to get exposure to real estate or, in the case of ETFs, any sector. Which one is right for you? Well that depends on your situation. I should note that this is not an endorsement of any financial products, you should definitely talk to an investment professional (which I am most certainly not) for that. Although, if I were to ever get a tattoo it would probably be the SPDR logo. On that note, good luck creating your diversified portfolio. And remember, it’s possible to invest in real estate without investing in real estate.