Building A Dividend Stream With The Best U.S. REIT ETF
Summary The uncertainty around the interest rate hike was not resolved in September. The high level of volatility is expected to continue in the coming months as well. Take advantage of the occasional dips to build a position in an income stream ETF. Back in June, after the second quarter of high volatility in the REIT sector, I wrote about the opportunity in U.S. REITs. The latest dip was marked during the first half of September towards the Fed’s decision when we saw both the REITs and utilities dropping dramatically. Since the Fed announced that it is essentially pushing out its decision to a later date, there is no reason to believe that the high volatility is behind us and that we will not see high levels of anxiety towards the Fed’s announcements, the one in October or in December. The volatility in REITs is well seen in this Vanguard REIT Index ETF (NYSEARCA: VNQ ) graph. The ETF hit $72 just after Yellen’s announcement, but in the following couple of weeks, it rallied pretty nicely, closing at $75 on September 25. (click to enlarge) Is it still the best U.S. REIT ETF? The next table compares VNQ to the other 15 ETFs that are focused on U.S. REITs. I marked the top five in each of the categories of dividend yield, management fees and the total return during the last 3 and 5 years in green. (click to enlarge) VNQ was favorable in all of the categories, delivering more than 4% yearly yield at only 0.12% yearly management fees with an impressive 72% return during the recent five years. Throughout 2015, through times of uncertainty and concerns, not only has VNQ continued to pay uninterrupted dividends, but also on top of that it grew its dividends by ~10% compared to the year before. The next graph shows VNQ’s quarterly dividends starting Q1’10 until the recent Q3’15. For Q4’15, I have plugged a $1.1 dividend, which is equal to the one paid back in Q4’14. While the other three dividends this year went up by 10%, it would be very hard to believe that the forth one will not grow, but I always like to be conservative: (click to enlarge) How can we model it forward? The 2015 dividend per share is estimated at $3.13, growing 10% year over year. An investor who wants to build a position during the next 10 years can generate some interesting strategies assuming they are willing to invest in VNQ regularly. What can one expect from this type of investment? First thing, let’s examine the dividend growth rate. Nothing can grow forever at the level of 10%. Moreover, this sector like any other sector is exposed to risks. REIT risks are associated with macroeconomic slowdown, space overflow and rental pricing. For a long-term model, let’s judge the growth rate to be 4-5% per year for the next decade. Model Assumptions Dividend rate: The current VNQ dividend rate is 4.2%. Let’s use it in the first year. Dividend growth rate: If we should pick a number between 4% and 5%, let’s go with 4.5%. Tax rate: Since not every investment can be tax free, let’s assume a 25% tax rate on the dividends. Investment: $1,000 invested per month or $12,000 yearly investment across a time period of ten years. The dividends, net of taxes, are assumed to be reinvested as well. VNQ’s price: The ETF price across the years is highly unknown. In order to mitigate that, let’s look at two scenarios. Scenario 1: VNQ’s yearly prices change at the same pace as the dividend per share. That means that in this scenario the ETF price will go up by 4.5% every year. Scenario 2: VNQ’s price remains at $75, or in other words the investment and reinvestment are taking place through the time of dips in the ETF pricing. Scenario 1 results In this case, where the ETF prices are growing alongside the dividend per share, after ten years, the investor has accumulated a holding of 2,093 VNQ shares. This holding has the potential to generate $9,739 in dividends per year. The investor invested $120,000 and therefore can expect 8.1% return on his investment in the tenth year. An income stream that potentially will continue to grow afterwards. Scenario 2 results In this scenario of flat ETF prices through the ten-year horizon, the amount of accumulated shares is ~30% higher than in scenario 1. The holding is getting to a total of 2,783 shares. It has the potential to generate a yearly income stream of $12,946 per year pre-tax. The following year, if we’re maintaining the same assumptions of reinvestment, the income stream after taxes is expected to exceed the $12,000 threshold. After ten years, the investor had invested $120,000 and expects to receive 10.8% in annual dividend return on his investment. Conclusions The anxiety regarding the interest rate will accompany us in the coming months and years. This will generate great opportunities for the long-term investor who is pursuing an income stream. The REIT sector is expected to grow even if the interest rate will rise. I find VNQ to be the best ETF that focuses on U.S. REITs. The patient investor has the potential to gain significant returns by setting their investment strategy straight. As there is no way to best optimize the entry or time the market, the investor should build a position through several purchases. And lastly, an investor should take advantage of the days of panic. These will be the days that will serve them well in the long run.