The Vanguard REIT index fund, ticker symbol VGSIX, has delivered 10.76% annual returns since its inception on May 13, 1996. The Vanguard REIT paid out $1 per share last year in distributions, with some of the payments being dividends (cash generated from the business) and some being returns of capital (non-taxable even in a taxable account until the amount of return of capital exceeds the original investment; at current rates, you wouldn’t have to worry about paying a return on capital tax unless you held this fund in a taxable account for over fifty years).
The total amount of cash that a Vanguard REIT investor receives over the full year is currently 4.16% given the market price of $24.02 for the fund shares. For a lot of people, REIT investing is an area where it can make sense to go the index fund route because route because the quality of an individual holding is extremely susceptible to the decisions of management–what kind of leases are being signed? What kind of rent escalators are being included? How much debt and share dilution is necessary to make that happen? If you select individual stocks, it is necessary to monitor the managerial competence of Simon Property Group in a way that you don’t need to keep up to date with, say, a firm like Hershey.
If real estate investing isn’t within your circle of competence, you can get diversification to the 152 largest companies in the sector that earn 7% returns on equity. You build a collection of businesses earning 7%, collect a little over 4% in income, pay your 0.26% in expense fees, and you’ll be on pace to get the historical returns of the Vanguard REIT which is 10.76%.
Possibly the best advantage of an index fund strategy is that you can have confidence purchasing shares of the fund during an economic disaster–in 2009, it’s a lot easier to say: “I think the Vanguard REIT index will recover because real estate investments won’t go away” than to say: “I believe this particular REIT stock that has fallen 70% in value and is currently losing money will recover.”
What I find most compelling about the Vanguard REIT is that fund investors on the eve of the real estate collapse have now earned 7.44% annual returns from January 31, 2006 through January 31, 2016. When the financial crisis happened, the value of a $10,000 Vanguard REIT investment slammed down to $5,400 before recovering in value to nearly $20,000 at the start of 2016.
This is a fund that almost certainly belongs in some type of tax shelter, although it does give some return of capital which would be more beneficial in a taxable account (i.e. the non-taxability of a return of capital is best exploited in a taxable account, but the predominant source of income is dividends taxed at the ordinary income rate which would be best exploited in a tax-deferred account).
Historically, the income from the Vanguard REIT has been enough to double one’s share count every 6.5 years with full dividends reinvested. In other words, even though the fund has only been around for twenty years, the the total returns experienced by the Vanguard REIT investors is noticeably different from what the returns would be if you just looked at the share price alone.
On May 13, 1996, when the Vanguard REIT debuted, the net asset value of the fund was $10. Today, it is $24.02. You might look at that and think, “Okay, that’s nice. You got over double your money during the past twenty years. Not terrible, but not great either.” But what cursory glance ignores is that Vanguard REIT holders have seen their share count climb over the past twenty years for those that chose to reinvest. Every share of the Vanguard REIT (VGSIX) created 2.54 new shares of the Vanguard REIT that got added to your share count since 1996.
The accurate understanding of the Vanguard REIT’s performance is that the share count doubled every 7.87 years since inception. For someone that invested $10,000 in the Vanguard REIT at the $10 inception for the fund, the share count would have increased from 1,000 shares in 1996 to 3,540 shares today. And then you combine that with the share price appreciation to see that a $10,000 investment of 1,000 shares in the Vanguard REIT has grown into 3,540 shares worth $24.02, or a total value of $85,030 in the Vanguard REIT as of the market close on February 12, 2016. Considering that the examination period included a devastating crash, I find it very impressive that the Vanguard Reit has delivered 750.3% cumulative returns in twenty years. As a reference point, the S&P 500 created 299.4% in cumulative wealth over the same time period.
I do think the character of the total returns might be a little bit different over the coming ten years compared to the past twenty. If you look at the top holdings of the Vanguard REIT, you will see: Simon Property Group, Equity Residential, AvalonBay, Ventas, and Boston Properties. These five REITs are focused on growing funds from operations rather than maximizing the distributions to shareholders. The reason they have become leaders of the index is because they have been growing cumulatively at a 9% rate over the past decade compared to 6% for REITs excluding these five.
They also provide starting dividend yields that are two percentage points lower than the rest of the index. This is why they have become the anchors of the REIT fund–the Vanguard REIT is created according to market cap, and therefore, the REITs that successfully pursue growth rather than distributions end up taking up a larger percentage of the index. The style of the Vanguard REIT is therefore drifting a bit in the direction of delivering returns through capital gains rather than distributions of current income, but it still delivers twice the income of the S&P 500.
I would classify the Vanguard REIT as a fund trading at fair value right now at $24.02. You’re not getting a deal on the fund, but you’re also not overpaying for sector exposure either. It’s attractive because you get exposure to 152 stocks that are growing at 7% and paying you 4%, though a percentage point of that is return of your own capital. The Vanguard REIT has a twenty-year record of 10.76% annual returns before fees and 10.5% annual returns net of fees, and my best guess is that long-term investors in the Vanguard REIT will get somewhere around 10% returns for the long term with this fund.
Sources Consulted: https://personal.vanguard.com/us/funds/snapshot?FundId=0123&FundIntExt=INT