Over the weekend, I enjoyed reading a few articles on this site that discussed how real estate investing, particularly in REITs, has outperformed many other investment strategies historically, As many of my regular readers could likely tell you, real estate has long been an area that I have invested in, along with being on the deal team in a few private equity real estate transactions. As you might gather then, this prompted me to investigate ways for everybody to be able to profit off of the real estate sector. One of the easiest and effective ways that I found is for investors to purchase shares of the Fidelity MSCI Real Estate ETF (NYSEARCA:FREL).
About The Fund
The Fidelity MSCI Real Estate ETF is designed to track the performance of the MSCI USA IMI Real Estate Index, which is meant to track the performance of the real estate sector in the United States. As many American companies that operate in the real estate sector are structured as real estate investment trusts, we might expect this fund to consist primarily of REITs and that is indeed the case. Here are the top ten holdings of the ETF:
Source: FREL Website
As we can see here, the holdings of the fund come from a variety of real estate sectors. For example, American Tower (AMT) owns cell phone towers, Simon Property Group (SPG) owns shopping malls, and so forth. This is nice to see as some of these sectors are more resistant to economic problems than others, which is likely something that has been on many investors' minds lately. By spreading out the money in the portfolio across a variety of different real estate sub-sectors, the fund is able to protect its investors against problems in one particular market while still exposing them to the potential profits of that market.
As my regular readers are no doubt well aware, I generally dislike seeing any single holding in the fund to account for more than 5% of its assets. This is because such outsized weightings expose the fund to idiosyncratic risks. For example, if some event causes the stock of a highly-weighted company to decline sharply, it will likely have a very noticeable impact on the value of the fund.
Here we can see two such heavily-weighted companies, American Tower and Simon Property Group. While American Tower is likely to be resistant to economic cycles, the same cannot be said for Simon Property Group, which is at least somewhat exposed to fluctuations in consumer spending.
Why Real Estate?
While there are certainly many methods that can be used to invest in real estate, the method used by the fund is mostly through REITs. Real estate investment trusts, commonly called REITs, were created by an act of Congress in the 1960s as a tax-advantaged way for ordinary investors to gain exposure to the real estate sector. In exchange for distributing 90% of their taxable net income to investors in the form of dividends, companies utilizing this structure would be exempt from corporate taxes. Investors receiving those dividends would be taxed on them at their ordinary income tax rate.
Real estate itself is an investment that often requires minimal capital expenditures outside of the cost of purchasing the property yet it is able to generate relatively steady income from the rents paid by tenants. As might be expected then, this results in the companies in this sector paying out higher dividends than the S&P 500 (SPY).
This is one reason why retirees especially like real estate investment trusts because they can often achieve their 4% annual withdrawals (the "4% rule") solely by withdrawing the dividends, never having to sell any of the trust units. This can be quite nice in times of market turbulence as their income is largely independent of the market as a whole.
There are other reasons for younger people to invest in REITs as well. The most important of these is that REITs tend to beat the broader market over time. As my fellow contributor Brad Thomas points out, real estate investment trusts have outperformed the S&P 500 index by an average of 190 basis points annually over the past twenty years:
Over the course of a 40-50 year career, 190 basis points annually adds up to a lot of extra money! Thus, while I would certainly never advocate putting all of your money into real estate, ignoring the sector is handicapping your retirement.
Distributions
When we consider the focus that the underlying assets have on dividends, it would be logical to assume that FREL pays out a relatively solid distribution itself. This is indeed the case as the fund currently has a trailing distribution yield of 5.43%. As is often the case with ETFs though, the distribution tends to vary significantly from quarter to quarter. We can see that here:
Source: FREL Website
One of the reasons for the fluctuating distribution is the exchange-traded fund structure. This structure causes the number of shares to constantly fluctuate and thus changes in the number of outstanding fund shares between the time that the fund receives the dividends from the underlying companies and the payment date of the distributions results in the dividend income being split among a differing number of shares. Over time though, this does balance out and an investor's total returns are in-line with the underlying index minus fund expenses.
Expenses
There are a few similar funds to FREL such as the iShares U.S. Real Estate ETF (IYR) and the Vanguard Real Estate ETF (VNQ) so why should you buy this one? The main answer to that question lies in expenses. As a rule, the higher a fund's expenses, the lower your returns will be. Here are the expense ratios of each of the three ETFs:
Fund Name Fund Ticker Expense Ratio Fidelity MSCI Real Estate ETF FREF 0.084% iShares U.S. Real Estate ETF IYR 0.43% Vanguard Real Estate ETF VNQ 0.12%
As we can see here, FREL is quite a bit cheaper than the iShares ETF and even beats low-cost Vanguard by 18 basis points! As the lower the expense ratio, the more of your returns you get to keep, this should cause the Fidelity fund to perform somewhat better over time.
Conclusion
In conclusion, real estate and REITs are an asset class that belongs in any investor's portfolio. The easiest way for most people to gain this exposure is by adding a well-diversified low-cost index ETF like FREL. The ETF's very low expense ratio should result in it outperforming competing funds and the high distribution should be appreciated by retirees and others depending on their portfolio for income. Overall, the fund should certainly be considered for at least part of your portfolio.
Power Hedge
Power Hedge has been covering both traditional and renewable energy since 2010. He targets primarily international companies of all sizes that hold a competitive advantage and pay dividends with strong yields.
He is the leader of the investing group Energy Profits in Dividends where he focuses on generating income through energy stocks and CEFs while managing risk through options. He also provides micro and macro-analysis of both domestic and international energy companie. Learn more.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I am invested in real-estate focused CEFs that may hold some of the same stocks that FREL does.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
