Relative Performance of Real Estate Exchange Traded Funds

Based on research by Dr. Kimberly Goodwin and Dr. Srinidhi Kanuri

In the spring of 2022, members of the American Real Estate Society selected this research article for the 2021 BEST PAPER AWARD in the Journal of Real Estate Portfolio Management.

Exchange traded funds (ETFs) are essentially mutual funds that investors can trade like an individual stock. They provide investors with a convenient and cost-effective way to diversify a small investment across a wide range of companies or industries. ETFs have been available as an investment product for over 20 years and represent almost $5 billion in assets under management in the U.S. and $10 trillion worldwide.

Real estate ETFs were first introduced in 2000 as a way for investors to easily make smaller investments in different types of publicly traded real estate companies. Most of these real estate firms are real estate investment trusts (REITs), which is a special organizational structure for real estate firms. Decades of research have focused on the unique characteristics of real estate investment and the diversification benefits it brings to a typical mixed asset portfolio over the long run. Real estate investment can provide a hedge against inflation and reduce portfolio risk during market downturns. Using data from 2003 through 2019, Drs. Goodwin and Kanuri examined whether investing in real estate ETFs actually provided benefits over the S&P 500.

Over this time, real estate ETFs had a median monthly return of 1.53% while the S&P had a median monthly return of just 1.36%. The real estate ETF portfolio, however, also had a higher standard deviation of returns with 6.09% compared to 3.87% for the S&P 500. In fact, monthly returns for the real estate ETF portfolio varied between -30% and +30%. No matter how Drs. Goodwin and Kanuri analyzed the risk and return characteristics, the S&P 500 always proved to be the superior investment by providing a better tradeoff between risk and return.

Drs. Goodwin and Kanuri, however, caution anyone from concluding that real estate ETFs are a bad investment. They note that 2007-08 were abnormally bad for real estate investments because the financial crisis was coined the “housing crisis” and resulted in crippling declines for the entire real estate sector. The truth didn’t come out until 200809 when people realized there was nothing wrong with the actual real estate and just the institutions that did the lending. Real estate ETFs rebounded with returns above 25% in 2009 and 2010.

Real estate ETFs suffer from a lack of diversification because most of them invest in a very similar group of REITs, and there is evidence that they have increased the volatility of the underlying REIT shares. REITs have become more correlated with the stock market over time, and several large REITs are already a part of the S&P 500. Investors who have a slightly higher appetite for risk can certainly benefit from the higher returns generated by real estate ETFs. Others, however, may find that real estate ETFs are less desirable and lack the stability that many investors expect to find in real estate investments.

To read the full research article, see:

Goodwin, K. R., Kanuri, S. Relative Performance of Real Estate Exchange Traded Funds. Journal of Real Estate Portfolio Management, 27(1), 78-87.