3 ETFs, That, Like Hello Kitty, Are Lies

August 28, 2014

3. Real Estate ETFs

Much like natural resources, investors turn to real estate ETFs hoping to get exposure to, well, you know, real estate. The problem is that the vast majority of real estate in the world is privately held, and not just homes—commercial real estate, farm land, timber—the majority of it is off limits to any fund trying to invest. Still, the convenience of the ETF package has rocketed the assets of funds like the Vanguard REIT ETF (VNQ | A-88), which has nearly $25 billion in assets.

On the one hand, funds like VNQ do what they say they’re going to do—they buy REITs. But on the other, they’re not really providing exposure to the core premise of real estate. There are real issues with using REITs as the path to your real estate exposure.

REITs invest in income-producing rental properties, and are required to distribute 90 percent of their profits to shareholders. That means no reinvestment, so, in order to grow, REITs are constantly on the prowl for new debt and equity investment to build the next mall or hospital.

Worse, the nature of accounting is that the value of the actual property held by REITs is depreciated heavily, which is fine from a business operations perspective, but the opposite of what many investors think they’re doing—investing in an appreciating asset.

It’s good for reported earnings, but not really the point of, say, buying a plot of land and sitting on it for a generation. In other words, investing in REITs gives you exposure to one very, very narrow definition of what it means to “invest in real estate”—the version where you try and maximize your current income. Many investors I’ve talked to, however, think they’re buying property to sit on for decades, believing that, like their houses, it will just slowly appreciate without having to incur taxes.

So what you end up with is REITs that look almost like bonds, versus the very real and topsy-turvy real estate market:

VNQ

Conclusion: Look Past The Whiskers
None of these classes of ETFs—volatility, natural resources or real estate—is actually doing anything wrong. At a prospectus level, each is doing exactly what it says it’s going to do. In the same way, Hello Kitty has been wandering around for 40 years playing dress-up, walking on four legs, speaking Japanese or English and carrying a purse. Nobody should really be surprised she’s not a cat. Just like you shouldn’t be surprised when your REIT isn’t sitting on fallow farmland.

You just have to look past the pointy ears and the whiskers.


 

At the time of this writing, the author held no positions in the securities mentioned. His children may, however, own Hello Kitty pencil cases. Reach Dave Nadig at [email protected], or follow him on Twitter @DaveNadig.


Find your next ETF

Reset All