RIET: High Dividend Potential With This Unique Real Estate ETF

RIET takes a unique approach to capturing high dividend income while moderating risk

In March, 2019, Hoya Capital Real Estate, a research-focused investment advisor with expertise in real estate securities, released its first ETF, the Hoya Capital Housing ETF (HOMZ).

Roughly two-and-a half years later, Hoya has now followed up with its second ETF, the Hoya Capital High Dividend Yield ETF (RIET).

A Little History

As it happens, in August, 2019 I was among the first ETF-focused authors to review HOMZ. Now, we fast-forward to 2021.

This past June, my wife and I decided to downsize. We put our home on the market and ultimately closed the sale. As a result, I was faced with the challenge of investing the proceeds until such time as we make a decision on what, and where, we will purchase to replace it.

So, I decided to revisit “The Housing ETF,” as it is referred to, with the goal of evaluating the progress it had made since that first review as well as deciding whether it was a good place to invest a portion of those funds. I reviewed it for a second time, and ultimately decided to include an allocation in my personal portfolio.

Introducing Hoya Capital High Dividend Yield ETF

But enough of that. Let’s get to RIET, the story for today.

An examination of the materials provided by Hoya make it quite obvious that RIET is truly intended to be a stablemate or sibling, if you will, of HOMZ. What do I mean by that?

One of the things that intrigued me about HOMZ is that I could see that it was slanted a little more towards growth than perhaps your typical REIT-exclusive ETF. For those interested, check out the links to my previous articles, and you will see why this is the case.

Has it played out that way since HOMZ’s inception? Using Portfolio Visualizer, I ran a comparison of HOMZ with venerable Vanguard Real Estate ETF (VNQ). Have a look.

Source: Portfolio Visualizer Backtest - HOMZ vs. VNQ

If HOMZ was designed to capture growth, RIET comes at things from a different vantage point. Simply put, RIET attempts to capture high current income while keeping the risk profile modest.

Stop for a moment to ponder that last sentence. Under current market conditions, you may have noticed that meaningful income is getting harder and harder to come by. Often, investors find themselves forced to settle for either a low level of income, one that may not even keep up with inflation, or to venture farther and farther out on the risk profile, with all the concerns that brings.

Let’s take a look at how RIET hopes to cope with that challenge. Starting in the next section, I will offer an overview of the various components.

Dividend Champions

Before we go any further, let’s briefly talk about one key difference between RIET and HOMZ. While HOMZ is a real-estate focused ETF, REITS and real estate operating companies only comprise approximately 30% of its holdings, with other types of entities completing the equation.

In contrast, RIET is 100% comprised of REITS and real estate operating companies, as expressed below in its prospectus.

The Index is expected to be primarily composed of companies that qualify as REITs under the Internal Revenue Code of 1986, as amended (the “Code”), but may also include real estate operating companies that do not qualify as REITs.

As can be seen in the following graphic, the chosen securities break down into 5 categories.

Source: Hoya Capital RIET Fact Sheet

Similar to HOMZ, as opposed to the market-cap weighting common in many ETFs, RIET takes a more equally-weighted approach. However, if you look closely, you will notice a slight bias towards what are referred to as Dividend Champions and large-cap ETFs. Mid-cap and small-cap REITS receive a slightly smaller weighting, and Preferred Stock comprises yet a smaller weighting.

Let’s start with that first category. What, exactly, is a “Dividend Champion?”

First of all, entities are sorted and classified into 1 of the 14 property sectors shown below, based on percentage of revenues derived from that particular sector.

Source: Hoya Capital RIET Fact Sheet

Here’s how RIET’s prospectus explains what happens next.

The Index then identifies the group of ten “Dividend Champions” by starting with the two largest companies by market capitalization in each Property Sector and selecting the one in each Property Sector with the highest dividend yield based on the company’s most recent ordinary dividend. From this group of 14 companies (one from each Property Sector), the two companies with the lowest dividend yield and the two companies with the highest debt ratio are set aside, leaving ten “Dividend Champions” that will be included in the Index.

As can be seen, for this purpose, the “winner,” if you will, is chosen from each property sector. Of those 14 companies, four are deliberately eliminated. The competing criteria for elimination are most interesting. Two are eliminated because their dividend yield falls short. The other two are eliminated in an effort to minimize risk, as identified by having the highest debt ratios in the group. That exercise leaves 10 remaining entities, designated as Dividend Champions.

Here, then, we see RIET’s first attempt to, as I worded it earlier, capture high current income while keeping the risk profile modest.

Filling In The REITS

After the 10 Dividend Champions are selected, 60 additional REITS are included, for a total of 70 entities in the index to this point.

This is done by sorting the remaining companies based on dividend yield, and selecting the highest yielding companies from the large-, mid-, and small-cap market tiers. No more than 6 companies from each Property Sector are included in each Market Cap Tier.

The inclusion of mid-cap and small-cap REITS from all property sectors, at roughly equal weightings, spreads out risk across a wide variety of entities. As noted in the prospectus, while mid- and small-cap REITS may come with a slightly greater level of risk as compared to their large-cap counterparts, in some cases these entities can be more nimble in responding to changing market conditions, including technological changes and adjustments in consumer preferences.

Preferred Stock

It is perhaps in this category that RIET is at its most innovative and intriguing.

What is preferred stock, in the context or REITS? REIT preferred stock is a type of hybrid security with both equity- and bond-like characteristics. Preferred stock typically has a senior claim to earnings and dividends vs. common stock, but junior to bonds. While this may vary, REIT preferred stock is often callable five years from the date of issuance, at which point it may be redeemed at par. As a result, in addition to income, there may be some potential for capital appreciation.

If you think about the above description, you can likely decipher that REIT preferred stock may often offer a higher yield, or current income, than common stock, but less opportunity for capital gains. Interestingly, as a result, in times of economic turbulence, the volatility of these instruments may be somewhat muted, as compared to common stock.

Here’s where RIET gets intriguing. REIT preferred stocks are not necessarily the easiest securities to trade. As a result, most ETFs have tended to ignore them in their portfolios. One notable exception is InfraCap REIT Preferred ETF (PFFR), which invests exclusively in these securities. Several closed-end funds include REIT preferred stocks, but it is often the case that these carry expense ratios of 1.50 - 2.00%.

Using a rules-based process, Hoya Capital will include 30 carefully-selected such securities in RIET, at a weighting of .33% per constituent.

Again, another unique approach to that goal; capture high current income while keeping the risk profile modest.

Summary And Conclusion

Similar to HOMZ, released in 2019, RIET offers an innovative take on real estate investing. It invests in 100 of the highest-yielding real estate securities, spanning both common and preferred stock. While several closed-end funds do this, it appears Hoya Capital is the first to offer this in an ETF wrapper.

Since both RIET and HOMZ take an approach closer to equal-weighting as opposed to market cap-weighting, it may prove that this increases your true diversification as opposed to a heavy concentration in a few securities.

RIET intends to pay monthly dividends, and the current overall dividend is projected to be in the range of 6.70%.

In terms of expense ratio, RIET’s press release states the following:

Hoya Capital also announced a fee waiver for RIET, lowering the net expense ratio to 0.25% from 0.50% until at least September 30, 2022, providing immediate value to investors at launch.

As mentioned towards the outset of the article, it seems clear that RIET is intended as a stablemate to HOMZ. Depending on the goals of a given investor, RIET, HOMZ, or some combination of the two may be able to be used to select a desired level of growth, income, and risk.

OK, there you have my take on RIET. I’d love to hear yours. Feel free to drop a note or question in the comments, and I will do my best to respond.