Tuesday, 8 March 2011

Real Estate ETFs on a Roll - Canada, USA, World

All the continuing bad news about the US housing market may be obscuring the fact that other parts of real estate have been in recovery mode for the past year in Canada, in the USA and to a lesser extent in the rest of the world. These other areas of real estate include Real Estate Investment Trusts (REITs) and ordinary real estate companies that own and manage office buildings, shopping malls, commercial property, apartment buildings, hotels, hospital buildings etc. In the past year ETFs focused on such real estate in Canada and internationally have returned 20 to 30%, and in the US around 40%.

Commentary suggests more good results may yet be in the offing - for example, the GlobeInvestor story REIT recovery inches ahead, Seeking Alpha's ING: Global REIT Returns Estimated at 8%-12% for 2011 and NASDAQ's REIT ETFs Can Do No Wrong.

The chart below from Google Finance shows the price movements (ie excluding the effect of distributions / dividends on returns) since mid 2008 for four representative ETFs - Canada's iShares S&P TSX Capped REIT Index Fund (TSX symbol: XRE), the USA's Vanguard REIT ETF (NYSE: VNQ), the Global SPDR Dow Jones Global Real Estate ETF (RWO) and the International (world excluding USA) SPDR Dow Jones International Real Estate ETF (RWX). The substantial rise in 2010 has only brought XRE back to just above the pre-2008 crisis level, while all of the rest are still significantly below recovery.

Though there are many other ETFs traded in the USA - see our recent post on ETF Resources for the databases to get the lists - we focus on the largest by asset size. Bigger asset size is better since that will reduce investor costs through smaller bid-ask price spreads, greater liquidity and tighter gaps between the funds' Net Asset Value and their market price. There are only three real estate ETFs trading in Canada so we review them all.

The ETFs

Canadian Holdings - these funds hold REITs with operations exclusively in Canada
USA Real Estate Holdings
Global Real Estate - holdings in many countries, including Canada and the USA
International Real Estate - holdings in many countries, excluding the USA. We list only this single fund, though again there a number of other similar funds, since their appeal is mainly to US investors.
Comparisons - details in the table below

Lowest Cost - The winner here is clearly VNQ - compared to its closest competitor, its asset size is more double and its Management Expense Ratio (MER) of 0.13% is half. The Claymore CGR offering has the highest MER. CGR does have the cost advantage that it is bought and sold in Canadian dollars on the TSX, which means an investor can avoid currency conversion costs to/from US dollars that are entailed when the US-traded ETFs are bought or sold. CGR's free optional dividend reinvestment, pre-authorized automatic purchase and systematic withdrawal programs save investors trading fees. Despite CGR being traded in CAD it is still subject to currency risk of the holdings since the fund does not hedge.

In Canada, XRE and ZRE have the same MER of 0.55%. XRE will have lower trading costs due to its much heftier asset base, while ZRE offers trading commission savings for those who wish to reinvest distributions through its free DRIP program.
Best Diversification - For Canadian holdings, ZRE comes out ahead of XRE since it has more holdings - 17 vs 13 (out of the 33 REITs in the country according to Investcom.com's current list) - and it weights its holdings equally, whereas XRE has a hefty concentration in one company - RioCan, at 25% of the fund.

For US real estate, VNQ is again tops with appreciably more holdings than any other fund.

Amongst global funds, FFR's 285 different holdings puts it ahead of the others

Room for Further Price Recovery - We suggested above that Canadian real estate has recovered the most towards pre-crisis levels. Canadian REITs are back to 2008 prices but the decline began before that and they are nowhere near the peak of 2007. The same applies for both US (VNQ) and international (RWX) real estate as the Google Finance graph below shows. International real estate has furthest to go. By the simple measure of Price/Earnings ratio, the global / international ETFs are still modestly priced compared to US ETFs - P/E in the mid teens for Global funds and only 10.4 for RWX. Distribution yields are also higher than for the US funds.

Rising Canadian Dollar has Reduced Returns for the Canadian Investor - The above chart includes the plot for the ETF with symbol FXC, an ETF that tracks the Canadian dollar against the US dollar. Since 2007, FXC (Canadian dollar) has risen 18%. This has reduced the returns of all the US-traded / US-dollar denominated ETFs accordingly. In the past year, the situation hasn't been quite as bad. At least net returns are positive instead of losses. We don't show the graph but the gains of RWX (+18%) and VNQ (+31%) have outstripped the 8% rise in FXC.

Canadian REITs Win for Taxable Accounts - Distributions received from all foreign holdings are taxed as ordinary income and do not benefit from reduced tax rates for dividends and capital gains or no tax at all for return of capital. In a registered account (RRSPs etc) tax rates don't matter but in a taxable account it can mean much better after-tax net returns. XRE has in the past given off half or more of its distributions as return of capital. ZRE is too new for the information to be available yet but it will also generate something similar.

Returns and Distributions - The comparison table shows that current cash distributions from US ETFs in the 3.1 to 3.4% range fall below those of Canadian (5.1 to 5.7%) and Global ETFs (3.5 to 7.0%).

Which ETF? - Based on the comparisons above, our preference for a Canadian holding is ZRE due to its lack of concentration and the DRIP, though XRE is pretty close. For the USA, the best choice looks to us to be VNQ and for the Global funds, RWO is first choice with the lowest MER, the largest asset base and second highest number of holdings. Across all the ETFs, the net returns will be far more influenced by the evolution of the real estate sector in various countries than by differences between the ETFs. All but ZRE use a very similar selection and weighting process for companies/REITs to hold. If one looks at the top ten holdings, the same companies show up across all the ETFs in each geographical group.

Real Estate in a Portfolio - Our previous posts on the subject, here and here, discussed the features and risks of real estate and mentioned the rule of thumb that such holdings should be limited to about 10% of a diversified portfolio. A Canadian investor might thus consider an allocation of 5% in a Canadian ETF and 5% in a Global ETF.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

1 comment:

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