The First Small-Cap REIT ETF

By Matthew McCall | June 16, 2011 AAA

The housing situation in the U.S. continues to weigh on the minds of homeowners nationwide. Prices continue to fall, and the number of homeowners with underwater mortgages is increasing. With that being said, it is interesting to find that the Real Estate Investment Trusts (REITs) have done well during the bull market rally. (To learn more about REITs, check out How To Analyze Real Estate Investment Trusts.)
TUTORIAL: Exploring Real Estate Investments

Raise the ROOF
Year-to-date the iShares Cohen & Steers Realty Major Index ETF (NYSE:ICF) is up about 5%, versus a mere near 1% loss for the S&P 500. And from the bottom in March, 2009, the ETF has more than tripled in value. Now, there is a new vehicle for investors who want to gain exposure to a portion of the REIT sector - the Index IQ U.S. Real Estate Small-Cap Index ETF (NYSE:ROOF). The ETF is composed of 36 small-cap REITs that most investors lack exposure to, because the typical REIT ETF is highly concentrated on the large-cap stocks.

During the last three calendar years (2008-2010), the small-cap index, which ROOF tracks, has beaten the large-cap index. The ETF charges an expense ratio of 0.69%, and the index that it tracks pays an annual divided yield of 5% (To learn more on how to value a REIT, see How To Assess A Real Estate Investment Trust (REIT).)

Top Holdings
Mortgage REITs make up 20% of the allocation, with retail REITs at 18%, office REITs at 17% and hotel REITs also at 17%. The diversification among a variety of small-cap REITs is a bonus for ROOF because it is not overly dependent on one niche area.

The top stock holding is Invesco Mortgage Capital (NYSE:IVR), a mortgage REIT that acquires, finances and manages mortgage-backed securities and loans. The REIT currently pays an annual dividend of 17.6%, and trades with a forward P/E ratio of 5.2. In the last 12 months, IVR is up approximately 1% - however, that does not include the $3.88 in dividends a holder of the stock would have received.

Office REIT Lexington Realty Trust (NYSE:LXP), the number-three holding in the ETF, currently pays a 5.2% dividend. The company concentrates on single-tenant commercial properties across the U.S. that are generally leased to major corporations. The stock has recently pulled back to its 200-day moving average at $8.50, and is once again looking attractive. The stock trades with a forward P/E ratio of 9.78.

Redwood Trust (NYSE:RWT) is considered a diversified REIT, but the majority of its business is related to investing in residential and commercial real estate loans and securities. The stock currently pays a 6.6% dividend, and trades at a forward P/E ratio of 12.19. Technically, the stock has struggled, but it has strong support at the $14 area.

The Bottom Line
The small-cap portion of the REIT sector has a three-year winning streak against its larger counterparts. Other than that, ROOF also provides an above-average dividend yield and (even more importantly), exposure to a niche sector that most investors ignore. Adding ROOF to a portfolio will further diversify a well-managed portfolio. (For more examples of other REITs and how to use them, check out 5 Types Of REITs And How To Invest In Them.)

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