Improved capital markets and positive liquidity trends led rating company Fitch to upgrade its outlook for U.S. equity REITs from negative to stable in June. However, the firm warned that while some companies may get ratings upgrades, a number have higher levels of debt and more speculative development pipelines and may be vulnerable to downgrades.

The REIT ETF Menu
Although REITs and their ETF prices have risen substantially since last year, the market volatility could create opportunities for those investors with a positive long-term outlook who want to pick up shares on dips in the market. The growth in REIT ETFs started several years ago with diversified U.S. REIT indexes and has expanded to include global and international markets, and even swelled to include such narrower niches as mortgage REITs and industrial properties. There is now a diverse stable of about 20 real estate indexed options to choose from. Here is a brief rundown of what's available.

Diversified U.S. REITs: The domestic publicly traded REIT universe is a relatively small one consisting of 134 companies. Of these, 111 are equity REITs that own and often manage commercial real estate and derive most of their revenue from rental income. Twenty of the remaining 23 REITs provide debt financing for commercial or residential properties by investing in mortgages and mortgage-backed securities. The others are hybrid REITs that engage in both activities. All of them are required by law to distribute 90% of their taxable earnings to shareholders in the form of dividends.

Because there are so few U.S. entities, the ETFs in this space tend to hold many of the same securities, and familiar names such as Simon Property Group, Vornado Realty, Public Storage and Boston Properties typically dominate the funds' top ten holdings. The returns and yields in the group also tend to be fairly similar. Expense ratios range from 0.12% for the Vanguard REIT ETF (VNQ) to 0.47% for the iShares Dow Jones U.S. Real Estate Index (IYR), the most liquid of the group. An expense ratio of 0.25% puts the SPDR Dow Jones REIT ETF (RWR) in between the other two options.

One offering, the iShares Cohen & Steers Realty Majors Index (ICF) is a more concentrated ETF that holds just 30 of the largest and most liquid REIT companies. That tight focus appeals to Morningstar analyst Patricia Oey, who finds this higher-quality portfolio favorable in the current challenging operating environment for real estate firms.

Diversified global and international REITs: "U.S. REITs now make up only about one-third of global real estate securities," says O'Connor. "So if you are just sticking to that corner of the market, you're missing out on the growth dynamics and diversification available from the other two-thirds of the investment universe." Because many foreign REITs have not rallied as strongly as their U.S. counterparts, their yields are somewhat higher.

This group focuses mainly on developed markets. A larger investment universe and more diverse geographic coverage means returns and yields are likely to vary more than they do within the U.S. group. The offerings in this group include the iShares FTSE EPRA/NAREIT Developed Asia Index Fund (IFAS), which focuses on markets in Hong Kong, Japan, Australia and Singapore. Another iShares offering, the FTSE EPRA/NAREIT ex-U.S. Index Fund (IFGL), includes those countries as well as markets in France, the U.K. and Canada. Both have expense ratios of 0.48%.

The most actively traded fund of this group, the SPDR Dow Jones International Real Estate Fund (RWX), has a larger presence outside of Asia than most of its competitors and an expense ratio of 0.59%. There are also global ETFs with both U.S. and foreign exposure, including the Cohen & Steers Global Realty Majors (GRI) and the First Trust FTSE EPRA/NAREIT Developed Markets Real Estate Index Fund (FFR).

Specialized and mortgage REITs: Mortgage REITs once dominated the market but now occupy only a small corner of it. The only REIT in this area, the iShares Mortgage Plus Capped Index Fund (REM), follows an index of mortgage REITs and banks and has a dividend yield of about 10%. S&P has assigned an overweight rank to the ETF.

At 25% of assets, Annaly Capital Management is by far the largest holding. Low short-term interest rates have enabled the company to profit from the spread between its cost of borrowing to buy mortgage-backed securities and the income generated by its portfolio. Other prominent holdings in the fund are Chimera Investment Corp., MFA Financial, New York Community Bancorp and Redwood Trust. Three other iShares REITs focus separately on residential real estate; industrial and office properties; and shopping malls and retail centers.