A tale of 3 REITs: XRE, ZRE and VRE
When it comes to ETFs, there are often multiple ETFs that aim to track the same index or asset-class and comparing them can be challenging. This is certainly the case with the three Canadian Real Estate Investment Trusts (“REITs”): XRE – iShares S&P TSX Capped REIT Index Fund, ZRE – BMO Equal Weight REITs Index ETF, and VRE – FTSE Canadian Capped REIT Index ETF.
REITs invest in real estate with a focus on income or cash-flow generating investment. This is typically accomplished through investments in mortgages, commercial real-estate or rental-focused residential buildings. Canadian REITs also provide significant tax advantages to investors. They avoid corporate taxes and are required to distribute 100% of their net taxable income to shareholders. REIT ETF distributions can be made up of rental income (which is treated as regular income for tax purposes), capital gains, dividends and the return of capital.
ZRE, XRE & VRE are all Canadian REIT index ETFs, however, they each differ somewhat in how they hold the index. XRE tracks the S&P/TSX Capped REIT Index, a modified cap-weighted index while VRE tracks the FTSE Canada All Cap Real Estate Index Capped 25% Index, a cap-weighted index which prevents individual holdings from exceeding 25%. ZRE differs the most in that it tracks an equal-weighted index of Canadian REITs where each holding is held in equal amount.
At the end of September, ZRE and XRE held 18 and 12 Canadian listed REITs respectively and VRE held 17 Securities that were either REITs or real estate services companies. Real estate services companies are those that have revenue that is generated from being involved in real estate such as FirstServices Inc. For ZRE the holdings are equally held at approximately 6%. With XRE and VRE, the top 10 holdings made up 84% and 78% respectively of the ETFs, with both of their largest holdings, Riocan and H&R, making up over 30%. In an asset class where there are few constituents, we feel using an equal-weighted index, like ZRE does, reduces the single name risk inherent in market-weighted indices.
ZRE, XRE, and VRE have 12-month trailing yields of 5.05%, 5.05%, and 1.97%. VRE’s has a lower 12 Month yield due to a combination of its holding and its structure not generating the return of capital to smoothen the monthly distribution.
As VRE has only been in operation since 2012 it is difficult to compare long-term performance between the 3 funds. Year to date performance ZRE, XRE, and VRE have returned 8.39%, 8.39%, and 9.46%. We should note that a 3-year return comparison between ZRE with 9.09% and XRE with 8.96%.
Other considerations should be fees, asset sizes, and liquidity. ZRE and XRE MERs are approximately 0.6% while VRE is 0.4%. Fund size and trading volume is often a reasonable indication of liquidity. XRE is the largest with $1.25 billion of assets under management, then ZRE with $333 million and VRE with $55 million. Good liquidity means that the spread between the bid and ask price is narrow and often results in an investor being able to purchase an ETF at a price close to its NAV.
We view Real Estate as a separate asset class to equities and fixed income. The benefits of real estate include income from rents and mortgages, capital appreciation, stable valuations, and diversification when added to a portfolio of equities and fixed income. At this moment the best way for us to access real estate for our clients is through REIT ETFs. They offer liquidity and a low-cost way to access this asset class. However, compared to physical real estate investments, REIT ETFs have greater volatility, mainly because they are listed on an exchange trade like a stock. Regardless of this, they have a relatively low correlation to equities and fixed income and therefore add significant diversification benefit to our portfolios.
Sources: Morningstar Direct