ETFs for a shaky real-estate market

Two funds draw on the strengths of a troubled sector while paying out steady dividends.

By TheStreet Staff Feb 15, 2011 12:07PM

Image: Home for sale (© Digital Vision Ltd.)By Don Dion, TheStreet

 

Despite facing staggering headwinds, the domestic marketplace has rebounded impressively from the depths of the recent recession. But while conditions appear to be improving across many sectors, there are still corners of this market that have me concerned.

 

Real estate, for instance, is one region that I feel will continue to be tricky to navigate, and it must be approached with extreme caution.

 

With exchange-traded funds, this slice of the market can be targeted from a number of angles, allowing investors to capture pockets of strength.

 

Residential real estate remains particularly worrisome as oversupply issues continue to weigh heavily on its long-term prospects. Homebuilder-focused funds such as the iShares Dow Jones U.S. Home Construction Index Fund (ITB) and SPDR S&P Homebuilders ETF (XHB) will likely experience volatility as the market sorts these issues out.

This week ITB and XHB may see a short-term pop if there is a strong new-home-sales report Wednesday. However, the longer-term picture for these two funds remains questionable and persistent turmoil appears to be in the cards.

 

While ETFs focused residential real estate appear destined for turmoil, funds designed to target real-estate investment trusts could make for far more solid investments for risk-tolerant investors.

 

On top of tapping into a more stable region real estate, REITs traditionally offer attractive distributions. The consistency of these payouts will provide added comfort when it comes to weathering economic turmoil in the coming weeks and months.

 

The iShares Dow Jones U.S. Real Estate Index Fund (IYR) and the iShares Cohen & Steers Realty Majors Index Fund (ICF) are two options investors can use to gain ample exposure to this industry. Although they share a similar aim, there a few differences to consider when determining which is best for you.

 

In both cases, companies include Simon Property (SPG), Vornado (VNO), Public Storage (PSA) and Boston Properties (BXP) among their top holdings. In fact, nine out of the top 10 holdings of IYR and ICF are identical to one another.

 

The biggest separation between these two products lies in their diversification. While IYR's benchmark, the Dow Jones Real Estate Index, is composed of 79 components, ICF's portfolio lists only 31 different holdings. Reflecting its more concentrated index, ICF sets aside a considerably larger percentage of its portfolio to its top 10 largest positions. Together, these components account for 60% of the fund's portfolio. IYR's 10 largest holdings represent 41% of the fund's assets.

IYR's broader reach may be attractive to conservative-minded investors. However, this added diversification comes at a price. Investors looking to use IYR to tap into the real-estate market face a 0.47% expense ratio. ICF, on the other hand charges, only 0.35%.

 

ICF and IYR allow investors to capture a relatively stable component of real estate. However, the risk of volatility persists. Therefore, investors must continue to tread carefully within this sector. By keeping exposure small and focused, you can avoid getting tossed around by turmoil.

 

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