Buying individual stocks is time-consuming, and some investors may not want to (or be able to) put in the effort, at least not across every sector of the market. That's why you might want to consider taking a different approach with some niche areas, like real estate investment trusts (REITs). REITs are known for offering high yields, but they are a bit unique and need to be looked at differently than many other sectors. This is why you might want to buy the Vanguard Real Estate Index ETF(NYSEMKT: VNQ) or Cohen & Steers Quality Realty Income Fund(NYSE: RQI).
REITs in three ways
You can clearly go out and look through the hundreds of REITs and try to pick one or a few for your portfolio. That's the traditional approach to investing, with longtime dividend-paying companies like Realty Income(NYSE: O), Federal Realty (NYSE: FRT), and Avalonbay(NYSE: AVB) all great starting points. But there are some important differences between even these three, with Realty Income a net lease REIT, Federal Realty a strip mall and mixed use landlord, and Avalonbay focused on apartments. Yes, they are all REITs, but the sectors in which they operate are quite different.
Image source: Getty Images.
If you just want exposure to dividend-paying real estate stocks, you might want to go with a pooled investment vehicle of some sort, so you don't have to put in too much legwork. The simplest way to do that is probably with an exchange-traded fund (ETF). Most ETFs track an index, providing broad exposure to the overall market or a sub-sector, like REITs.
If you want more focus than that, you can buy an actively managed ETF, mutual fund, or closed-end fund. ETFs and closed-end funds trade all day on the stock exchanges, like a traditional stock. Mutual funds stand ready to buy and sell shares at the end of every trading day. The more important distinction here compared to an index fund, however, is that there is a human being picking stocks for investors.
Two specific options
When it comes to index-based ETFs, one of the largest options in the REIT space is the Vanguard Real Estate Index ETF. There is nearly $60 billion in assets in the ETF, which means it is highly unlikely to get shut down (tiny ETFs are often here today and gone tomorrow). The management fee is a very reasonable 0.12%, so it is a very low-cost way to get exposure to the REIT sector. The dividend yield is currently around 4.3%.
This ETF tracks the MSCI US Investable Market Real Estate 25/50 Index, which is designed to provide broad exposure to the REIT sector. The ETF invests across 17 different property niches, from timber to data centers, with industrial REITs representing the largest exposure at just about 14% of the portfolio. It holds 164 positions. This is a simple, "one and done" investment option that won't be exciting but will give you broad exposure to REITs without requiring much time and effort.
At the other end of the spectrum is the Cohen & Steers Quality Income Realty Fund, an actively managed closed-end fund. Closed-end funds issue shares like a company, so the assets this fund manages remain even as shareholders trade it. Thus, it can invest in REITs without the fear that redemptions will require it to sell stocks to meet those redemptions, an issue for open-end mutual funds. The Cohen & Steers Quality Income Realty Fund has a huge 8.5% yield.
As the name suggests, the Cohen & Steers Quality Income Realty Fund is looking to invest in REITs that management considers best in breed. But with over 200 holdings, it still has fairly broad exposure to the entire REIT sector. The difference is that management selectively overweights the stocks it likes best. For example, both the Vanguard ETF and this fund own Realty Income and healthcare REIT Welltower(NYSE: WELL), but Cohen & Steers has invested about twice as much of its fund in each. As the chart below shows, this closed-end fund has bested the Vanguard ETF on a total return basis (which assumes dividend reinvestment) over the past decade.
RQI Total Return Price data by YCharts
There's another nuance here that's important. Cohen & Steers Quality Income Realty Fund makes use of leverage. That can make the shares more volatile, but as long as it can earn more from its investments than the cost of the debt it takes on, investors end up winning in the long term. This is also part of the reason that the fund can pay such a high dividend. That said, the cost of leverage increases the expense ratio, which sits at a lofty 1.9%.
That's a big number, but if you are looking to maximize the income stream your portfolio generates, it could easily be worth the expense to get access to the investment skills of Cohen & Steers. This asset management company was one of the first to offer funds dedicated to REITs and is a well-regarded industry specialist.
A hands-off approach
The big takeaway here is that you don't have to buy individual REITs to get exposure to the REIT sector -- there are other options. The simplest is probably an index-based ETF like the Vanguard Real Estate Index ETF. That should suit most investors' needs, particularly if the desire to own REITs is asset allocation driven. For investors looking to add income to their portfolios, however, there are other strong choices with far higher yields.
The Cohen & Steers Quality Income Realty Fund is a solid choice focused on top-tier REITs. The use of leverage increases risk, but that's also why it can offer such a large dividend. It's a trade-off that may make sense for more aggressive investors.
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Reuben Gregg Brewer has positions in Federal Realty Investment Trust and Realty Income. The Motley Fool has positions in and recommends Vanguard Specialized Funds-Vanguard Real Estate ETF. The Motley Fool recommends AvalonBay Communities and Realty Income. The Motley Fool has a disclosure policy.
