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ETF Specialist

Finding Room for Income With REITs

Investors seeking yield in REITs have been rewarded, but don't expect great diversification anymore.

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REITs have been one of the strongest-performing investments over the past three years, beating the S&P 500 solidly.  Vanguard REIT Index ETF (VNQ) is our favorite way for ETF investors to gain exposure to the broad income-generating real estate market. VNQ invests in a cap-weighted survey of United States equity REITs, allowing investors to access the movement of REITs across sector and capitalization in one cheap package. And cheap it is: VNQ charges a bargain 0.10% expense ratio, the lowest in its category. Because REIT funds have very similar returns pre-expenses, low cost is one of the most important factors for picking which to invest in. VNQ's low price has helped it outperform its competitors on a regular basis. It is by far the largest REIT ETF with over $14 billion in assets, and the second most liquid. Just as there is much to like about REITs, there is much to like about VNQ.

REITs are a hybrid asset class, offering bondlike yields and the possibility of capital appreciation. Investors starved for yield and hungry for dividends will find REIT ETFs particularly attractive. VNQ yields almost 2 percentage points more than the current paltry 1.6% offered by 10-year Treasuries. Historically REITs were a great diversifier because of low correlation with equities, but today they offer few such benefits; REITs are best thought of as part of a diversified equity allocation. Unlike equities, however, income-generating real estate has some inflation-hedging qualities because property prices move in line with inflation and nonsticky rents can change as needed. Historically, an investment in VNQ has preserved purchasing power.

Abby Woodham does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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