ROOF NYLI CBRE NextGen Real Estate ETF

The real estate segment has been a huge winner this year despite the ongoing chaos in the European market and the uncertain U.S. growth outlook. This is largely thanks to strengthening commercial real estate fundamentals, recovering housing sentiments, high dividend payouts and low interest rates are making securities in this segment attractive at present.

Investors looking to cycle their exposure back to the market might consider real estate ETFs for their exposure. These have often outperformed the other traditional safe havens such as bonds and gold, suggesting that they have also become a solid bet as of late (read: Real Estate ETFs: Unexpected Safe Haven).

Though many U.S. real estate ETFs have gained more than 10% so far this year, the small cap IQ US Real Estate Small Cap ETF (ROOF) has outpaced its large counterparts in the space such as Vanguard REIT ETF (VNQ) and iShares Dow Jones US Real Estate Index Fund (IYR) by at least 700 bps in the year to date time frame, meaning that small caps are leading the charge back higher.

Small Cap Real Estate ETF

As the real estate market recovers, small cap real estate ETFs are poised to benefit enormously from the current market environment, implying that they could continue to outperform heir large cap counterparts as the year progresses. This is because small caps are less vulnerable to global trends, tend to do better on average in rising markets, and can potentially offer a different—and hopefully better—sector mix than their large cap peers in changing markets (read: Small Cap Real Estate ETFs: Crushing The Competition).

On the other hand, large caps are multinational firms that are highly exposed to international markets and economic woes. As large cap firms have already reached their maturation, they have little ability for further expansion, thereby returning less.

Hence, small cap real estate ETFs could be considered the best option for investors seeking to play in the current real estate market. Further, small cap real estate ETFs often pay outstanding dividends when compared to other caps counterparts.

There are currently 14 non-leveraged mixed REITs U.S. ETFs in the space, of which 13 are multi-caps and one is small cap (see more ETFs in the Zacks ETF Center).

For better comparison, let us look into the following table that describes the returns and yields of the small cap and some multi caps real estate ETFs:

 

ETF	AUM (as of 08/10/12)	YTD Performance (as of 08/10/12)	1-Year Performance (as of 08/10/12)	Dividend Yield	Expense Ratio
ROOF	$29.1 M	21.09%	24.11%	4.54%	0.69%
VNQ	$13.6 B	15.12%	24.39%	3.30%	0.10%
IYR	$3.9 B	14.50%	21.30%	2.62%	0.47%

From the above table, it is clear that ROOF has generated impressive returns so far this year relative to their large cap counterparts. This is because the ETF is widely spread across several real estate markets — mortgage REITs (30.60%), office REITs (16.57%), retail REITs (14.21%), specialized REITs (13.17%), hotel REITs (12.37%), diversified REITs (8.56%) and residential REITs (4.51%).

Not only does the fund have a wide exposure to different REITs, but it also has large diversification benefits with respect to individual holdings (read: Three ETFs with Incredible Diversification). With a basket of 41 securities, ROOF allocates about 43% in top 10 holdings, with no more than 7% in any one firm, while it has a low annual turnover as well of just 11%.

ROOF seeks to replicate the performance of the IQ US Real Estate Small Cap Index, which is a float adjusted market cap weighted index. Though the product charges a higher fee of 69 bps per annum from investors, it yields about 4.54% in annual dividend and has returned 21.09% year-to-date, which is considered the highest return in the space. The fund so far has managed assets worth $29.1 million since its launch in June 2011.

However, the fund is less liquid as it trades only 5,000 shares per day on average. This illiquid nature of the fund might raise the liquidity cost in the form of bid/ask spread (read: Use Caution When Trading These Three Illiquid ETFs).

Competition

Despite this outperformance, ROOF is by no means the most popular ETF in the real estate market. Instead that honor goes to VNQ which is the largest real estate ETF in the space with AUM of $13.6 billion, tracking the MSCI US REIT Index.

With holdings of 111 securities, the product puts 45.80% of the assets in top 10 companies, suggesting a greater concentration across individual firms. Looking at real estate market exposure, the fund is well diversified between retail REITs (27.50%), specialized REITs (27.40%), residential REITs (18.30%), office REITs (15.30%), diversified REITs (6.70%) and industrial REITs (4.80%).

Large cap accounts for about 45% of the assets while mid and small cap takes the remaining portion in the basket. The fund is liquid as it trades in higher volumes of 2.12 million shares per day on average, signifying that extra cost of investment is not involved or bid/ask spread is minimal. The product is one of the low cost choices in the space, charging only 10 bps in annual fees from investors (read: Guide to the 25 Cheapest ETFs).   

Similar to VNQ, IYR puts larger attention to its top 10 holdings (nearly 42% of assets) and is spread well across numerous REITs (read: Time for a Commercial Real Estate ETF?). Specialty REITs (27.44%) constitute the top spot in the basket, followed by retail (20.87%), industrial and office (19.77%), residential (13.92%), mortgage (8.79%), hotel and lodging (3.80%), real estate holding and development (2.19%), real estate services (1.66%) and diversified (1.37%).

The product seeks to replicate the Dow Jones U.S. Real Estate Index and holds 85 securities in the basket. It is tilted towards the large cap firms with roughly 48% market share and the rest comprising mid and small caps (Read: Try Value Investing With These Large Cap ETFs).

IYR charges higher annual fees and is highly traded relative to VNQ. The fund trades with average volume of 6.5 million shares per day. Launched in June 2000, the product has so far attracted $3.9 billion in assets under management.

Conclusion

From the above discussion, we can conclude that ROOF is the most diversified ETF across both sectors and securities. It offers higher returns with high yields and has a potential for further upside from the current levels.

Additionally, when looking at history, small cap real estate can be a solid pick when markets are rebounding, and even when the sector is seeing some weakness, its outsized yield is likely to help soothe investor worries and make ROOF a great pick no matter what the market conditions are.  

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ISHARS-DJ REAL (IYR): ETF Research Reports
 
IQ-US RE SC (ROOF): ETF Research Reports
 
VIPERS-REIT (VNQ): ETF Research Reports
 
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