There are hundreds of ETFs traded on the ASX and some are bound to overlap each other, but not all index funds are the same even if they invest in the same asset class. It is important for investors to understand differences between the index funds otherwise how else would you know the real risk of being an investor in the fund and the potential return of the investment?
How REITs work
REITs are a cost effective means for investors to gain exposure to commercial real estate assets such as office buildings, industrial warehouses/distribution centers, light factories and shopping centers.
REITs are tax efficient because the income and capital gains are not taxed on the trust level. Therefore REIT distributions are only taxed once when they reach investors.
REITs can follow a diversified sector strategy where it invests across multiple sectors that are called diversified REITs. On the other hand there are sector specific REITs that invest in a particular area of the real estate market like Westfield now known as Scentre which only owns shopping centers and Bunnings Property Trust which was spun off from Wesfarmers (owner of Bunnings) mostly own Bunnings stores.
What this means is that the underlying income of the REIT is based on the performance of the real estate assets it owns. By implication, the investor’s income is dependent on the performance of the REIT it owns in the portfolio which can be considered an implicit asset class choice in the commercial property sector.
There are no ASX residential REITs, mainly due to the attractive tax treatment of owning investment properties directly (i.e negative gearing) causing such mispricing in the form of cap rates of residential assets are much sharper than other forms of commercial real estate resulting in institutional capital being extremely uncompetitive.
Advantage of REIT ETF vs REIT
Overlay REITs with an ETF structure that tracks the REIT benchmark and you will have a diversified portfolio of REITs.
Income Consistency
Income distribution is the primary driver of returns in the asset class.
The dividend income from a REIT is highly dependent on the assets’ performance in the trust. If the properties are performing poorly, the manager will cut the dividend to preserve capital.
A benefit of investing in a portfolio of REITs is the consistency of the income stream it provides. ETFs provide beta exposure to the sector with the overall dividend of the ETF based on the sector’s performance as a whole.
Capital gains make up a large portion of the long term returns but it is hard to predict as it depends on factors outside of the investors’ control like interest rates, rent growth of the assets and cap rates.
Avoid the Losers (Winners)
It is hard enough to beat the index over the long run and if you just want sector exposure, REIT ETFs can be a very convenient and cheap means of achieving that goal as an ETF is about market exposure rather than specific stock picking. While we advocate doing detailed research on all our investments, an ETF is a quick means of adding a type of exposure to the portfolio.
Australian REIT ETFs (SLF vs VAP)
There are two large REIT ETFs listed on the ASX that can provide a portfolio exposure to the REIT sector.
We have categorized the primary points investors should focus on when looking to invest in a property securities fund and highlighted the good, bad and interesting points.
REIT ETF Benchmarks
There is a high degree of overlap of the REITs in SLF and VAP. SPDR S&P/ASX 200 Listed Property Fund (SLF) owns a portfolio of REITs from the ASX 200 index while Vanguard Australian Property Securities Index ETF (VAP) includes REITs from the ASX 300 index.
The difference here is as ASX VAP tracking index includes 100 more shares at the bottom end of the market size it provides a slightly higher degree of exposure to small capitalization REITs. The analysis below shows this will have a limited on the overall return compared to the ASX SLF.
ASX REIT ETF vs Australian Share Market
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The sector has underperformed the broader market recently Covid had a more direct impact on commercial real estate assets than other sectors like BNPL or healthcare shares as an example.
Some of these issues include retail REITs income being hit due to shutdowns leading to retailer’s reduced ability to pay rent. The consensus is that the value of retail assets will fall as the economy slows. By implication, it looks like REIT distributions have peaked and only cuts going forward.
As a result of this investors has exited their positions trying to avoid the worst. For long term investors who can withstand distribution cuts this can be an opportunity to buy into the sector but we think there will be a better time down the road.
Difference in Fees
Management fees can erode a large portion of investment returns over the long run. The advantage of ETFs has over managed funds is that ETFs are passive investment products. REIT ETFs’ goal is to track the index rather than pick winners and avoid losers there and the upside of an index is that the only goal of the index fund is to track the index which does not require a lot of cost to manage. Overall fees for ETFs are lower in index funds compared to actively managed funds.
SPDR S&P/ASX 200 Listed Property Fund charges 0.40% while as it is typical of the Vanguard index funds, the management fee of Vanguard Australian Property Securities Index ETF is only 0.23% per annum .
Portfolio Holdings
The overlap and minor differences in the underlying index both fund track limit the deviation in the returns. State Street SPDR (ASX SLF) holdings show it owns around 20 REITs and Vanguard Australian Property Securities Index ETF has 30 positions.
Top 10 holdings across either fund are the same but at different weightings. This is because VAP ETF owns REITs that are also included in the ASX 300 index, but the smaller market capitalized REIT contribution does not make a material difference.
We covered the list of property trusts on the ASX in detail separately but included some of the highlights below:
The 10 positions in the fund make up more than 80% of the portfolio. This is a highly concentrated portfolio where the fund’s top 5 positions make up 50% of the fund.
The largest position in the AREIT sector is one of the largest logistic fund manager in the world.
- Goodman
- Scentre Group (Westfield Australia)
- Dexus
- Mirvac
An investor in the REIT will be really taking a large exposure to these 5 stocks.
Sector Exposure
From a sector exposure perspective, all major sectors are represented with diversified, industrial, office and retail REITs make up more than 90%.
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REIT ETF Returns
12 Month Returns and Distributions History
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REITs are known to attract income focused investors and the key benefit of these ETFs is that the distributions are paid quarterly. Therefore it is a highly consistent income stream as long as the underlying investments are performing.
The REIT sector has performed strongly since the financial crisis. Managers actively repaired their balance sheets and have been conservative in managing their portfolios.
Going into the current crisis the overall gearing levels has been conservative and they learned the lessons of the GFC where they didn’t invest overseas and just focused on Australia. They were also able to raise capital so quick and did so as an extra layer of protection.
While overall REIT ETF yield is low by historical standards, it is still attractive as measured by the spread to cash or fixed income yields.
ASX VAP Dividends / ASX SLF Dividends
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Note that VAP pays the dividend one month after the record date while SLF will take up to 3 months after the record to make the dividend payment.
The consistency in the dividends in the last 5 years shows it could be ideal for looking for income and can ignore short term price volatility. However, it is important to know that investing in the fund is taking on a major exposure to the commercial real estate sector which we consider to be a volatile sector in the future.