ETF Basics: How to Own Rental Real Estate and Never Fix a Toilet

Why REIT ETFs are worth a look.

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Every retirement portfolio should contain real estate holdings. Sophisticated investors hold diversified real estate portfolios that can include portions of office buildings, apartments, industrial warehouses, retail centers, and shopping malls both in the United States and internationally.

Owning real estate has its own set of risks and benefits. A property that is well-located and leased gives you debt-like cash flow with the opportunity for appreciation like stocks. Leased buildings are valued based upon the stability of cash flow from rents and the cost to replace the building. Real estate also protects you against inflation, as its value tends to move closely with the costs required to replace it—think land, bricks, concrete, steel, labor, and fixtures. These costs rise with inflation, and landlords raise rents over time if inflation grows.

Most investors, however, don't want to buy a building. Fortunately, it's easy to own real estate without ever fixing a toilet, or worrying about a roof caving in during a winter storm. You can get a well-diversified real estate portfolio by owning real estate in the form of real estate investment trusts (REITs). These are unique public securities because they pay no taxes and pass through 90 percent of their income to investors in dividends. From 1970–2009, public REITs returned an average of 9.1 percent per year. That means money invested in REITs doubled every eight years!

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That doesn't mean real estate won't have ups and downs. REITs tend to trade in large swings between the fair value of the real estate held in the REIT to the stock price—from a 20 percent discount to a 20 percent premium. As you can see from the green box on this chart, between 2000 and 2009 REITs have been up or down by more than 35 percent. But while the stocks may swing, you can sleep at night knowing that you own hard, rent-paying assets.

The best way to own REITs is through an exchange traded fund (ETF) because the costs are low and you'd be hard-pressed to find an active fund manager with the expertise to consistently pick REITs over many years that will beat a REIT index. In fact, owning REITs through a mutual fund can cost you almost 50 percent of the yearly dividend you should receive, in manager fees. Therefore, instead of paying high fees, just buy an ETF that holds all of the REITs that matter. We recommend two SPDR Dow Jones ETFs in all of our portfolios to get REIT exposure: The SPDR Dow Jones REIT ETF (RWR) which indexes U.S. real estate and the SPDR Dow Jones International Real Estate ETF (RWX), which indexes international real estate.

For an annual fee of only 0.25 percent, RWR allows you to own the largest 81 REITs in the United States, including the largest American malls through Simon Malls, self-storage units at Public Storage Group, apartments, office buildings, and strip centers. Last year, investors received dividends of 3.61 percent.

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For a fee of only 0.59 percent, RWX allows you to own a piece of companies like the Westfield Group in Australia with shopping centers worldwide and apartments and hotels held outside of the United States by Mitsui Fodusan. RWX paid a dividend of 3.46 percent last year.

Not all real estate assets serve the same purpose. Your personal residence should not be considered part of a proper real estate allocation because it is one highly concentrated holding largely for personal consumption. Owning raw land, real estate development projects, and hotels are not considered part of this asset class. These investments' value relies upon the operating expertise of the principals, not the fundamentals of the real estate itself.

But owning REITs using an ETF gives you global exposure for a low cost and adds diversity to your portfolio. Make sure you have them among your retirement assets.

Mitch Tuchman is CEO and Founder of MarketRiders, an online investment advisory and management service helping Americans invest for retirement. MarketRiders gives investors greater piece of mind knowing that they are leveraging the best thinking of Nobel Laureates and the investing methods used by the world's most elite institutions and wealthiest families. MarketRiders is on the investor's side, helping reduce investment costs and risks, and increasing retirement savings.