Investors planning to play a possible post-Covid rebound by piling into property might want to pause for thought before buying into the largest real estate index funds in the US.
One of the quirks of indexing is that a capitalization weighted index owns more of the most-loved stocks and fewer of the least-loved ones, making market-cap weighted indices a difficult proposition for contrarians looking to buying trashed stocks, or those trying to benefit from reversions to the mean.
In few corners of the market is that phenomenon more striking than in the $30bn Vanguard Real Estate ETF (VNQ), which is stuffed with cell tower and data center landlords, rather than apartments, office buildings, malls, and hotels, that might rebound in a post-Covid world.
The fund is the largest property fund in the US and represents almost one quarter of the entire $126bn Morningstar Real Estate category.
Five of the fund’s top 10 holdings are either cell tower or data center real estate investment trusts (Reits), including American Tower, Crown Castle International, Equinix, Digital Realty Trust, and SBA Communications.
The fund’s top holding is another Vanguard real estate fund, Vanguard Real Estate II Index (VRTPX), which also has those five cell tower and data center Reits in its top 10 holdings.
VNQ has 12% of its assets in Vanguard Real Estate II, meaning the former fund has more than 8.5% of its assets in American Tower, more than 6% in Crown Castle International, more than 5% in Equinix, nearly 3% in Digital Realty Trust, and more than 2.5% in SBA Communications.
American Tower, Crown Castle, and SBA are cell tower companies, while Equinix and Digital Realty are data center landlords.
All of which means more than 25% of Vanguard Real Estate’s assets are in cell tower and data center companies. Another 6% of Vanguard Real Estate is in its third largest holding, Prologis, an industrial and logistics Reit that warehouses goods being shipped around the world and, like cell towers and data centers, benefits from the internet and e-commerce boom accelerated by Covid.
The fund is, of course, not devoid more traditional property names, with its list of top 10 holdings rounded out with Public Storage, a self-storage Reit, Simon Property Group, a mall Reit, and Welltower, a healthcare Reit.
Vanguard Real Estate’s top 10 holdings (November 30, 2020)
|Name||Ticker||Portfolio Weighting %|
|Vanguard Real Estate II Index||VRTPX||12.32|
|American Tower Corp||AMT||7.60|
|Crown Castle International Corp||CCI||5.35|
|Digital Realty Trust Inc||DLR||2.54|
|SBA Communications Corp||SBAC||2.38|
|Simon Property Group Inc||SPG||1.99|
Source: Morningstar Direct / Data as of November 30, 2021
Three years ago, at the end of 2017, the fund only had two data center Reits (Equinix and Digital Realty Trust) and no cell tower Reits in its top 10.
Simon was the top holding, occupying 5.6% of the portfolio, not counting its position in the Vanguard Real Estate II Index fund. Public Storage was the fifth largest holdings, while apartment landlords AvalonBay Communities and Equity Residential, occupied the sixth and eighth slots. In addition to Welltower, another healthcare Reit, Ventas, occupied the 10th slot.
Vanguard Real Estate’s top 10 holdings (December 31, 2017)
|Name||Ticker||Portfolio Weighting %|
|Vanguard REIT II Index||VRTPX||9.96|
|Simon Property Group Inc||SPG||5.60|
|AvalonBay Communities Inc||AVB||2.58|
|Digital Realty Trust Inc||DLR||2.45|
Source: Morningstar Direct / Data as of December 31, 2017
One of the reasons for this change in holdings is that the fund switched indices from the MSCI US REIT index to the MSCI US Investable Market Real Estate 25/50 index in February 2018. A statement published to investors at the time said the changed had been made so that the fund would track ‘a more expansive, diversified universe of real estate securities.’
Indeed the old index the fund tracked contains Equinix and Digital Realty Trust, but none of the cell tower firms.
The Vanguard fund is by means alone among property funds in having a heavy allocation to technology-related names.
The next two largest Reit ETFs, the $4.5bn Schwab US REIT ETF (SCHH), and the $4.2bn iShares US Real Estate ETF (IYR), both have the same cell tower companies among their top holdings and combined cell tower and data center allocations that rival VNQ’s.
The bottom line for investors in the largest Reit ETF is that they are getting a big dose of technology-related stocks, an allocation that has been a boon of late, but which may not benefit as much as they think from a more traditional property rebound.