Your Complete Guide to Index Investing with Dan Bortolotti

Why Has VRE Outperformed Its Rivals in 2013?

2017-12-02T21:27:54+00:00December 19th, 2013|Categories: Dividends, ETFs|Tags: |35 Comments

It’s been a marvellous year for equities, but 2013 has not been kind to real estate investment trusts. Like other income-producing investments, REITs are sensitive to rising interest rates, and the sharp increase in the middle of this year hit them hard. But the three Canadian ETFs in this asset class have shown significant differences in performance. Notably, the Vanguard FTSE Canadian Capped REIT (VRE) has outperformed its iShares and BMO rivals by a wide margin. Here are the year-to-date returns of the funds as of December 18, according to Morningstar:

Vanguard FTSE Canadian Capped REIT (VRE) –2.47%
iShares S&P/TSX Capped REIT (XRE) –7.81%
BMO Equal Weight REITs (ZRE) –6.72%

REISs pieces

Whenever you see variance among funds in the same asset class, it’s important to determine why. In this case, the main reason is a significant difference in the underlying indexes. Shortly after VRE was launched, I wrote a detailed post describing its benchmark, the FTSE Canada All Cap Real Estate Capped 25% Index, which is quite different from those tracked by the iShares and BMO funds.

Like XRE, the Vanguard ETF is cap-weighted, so it is quite concentrated in the country’s largest REITs: RioCan and H&R. However, unlike either of its competitors, VRE also includes real estate investment and services companies (REISs), which make up 18.5% of the fund. The largest, Brookfield Office Properties, has increased more than 25% this year, while the fund’s small holding in FirstService Corporation is up over 60%. These gave a huge boost to VRE.

Higher return, lower yield

Despite VRE’s higher total return, the ETF’s yield is inconsistent and significantly lower than that of its competitors. Its monthly payouts in 2013 have ranged from about $0.01 to $0.07 per unit, with a 12-month trailing yield of 2.16% (according to Morningstar), while XRE and ZRE have both sported yields over 5%.

Vanguard’s David Hoffman generously provided an explanation. There are actually a few things going on here. The first is simply that some of the underlying holdings pay smaller distributions. “The REISs in the portfolio provide a lower yield than the remaining REITs,” Hoffman explains. Brookfield Office Properties, for example, has a 12-month yield of 2.82%, about half of what RioCan paid out. FirstService yielded 0.47%.

The rest of the story is a more complicated. Mutual fund trusts (including ETFs) are required to distribute their income to unitholders in the year it is received, but not necessarily in the same month. Many funds hold back some of the income they receive in an effort to smooth out the monthly distributions. They may even top up the distributions with some return of capital when necessary. XRE, for example, has paid out about $0.06 per unit every month for over three years. Meanwhile, ZRE has paid exactly $0.081 for the last 15 months.

Vanguard doesn’t do that, Hoffman says. “We generally pay the income as it is earned, so at each distribution period income received since the prior distribution period is paid. This in part explains the inconsistency in monthly income per share for VRE, as the underlying securities do not pay concurrently. Three securities pay quarterly dividends, while the remaining pay monthly. The quarterly dividends are typically reflected in the distributions of the months following the calendar quarter, thus increasing the distribution rate of the fund in January, April, July and October if all else is equal.”

They also do not add return of capital to the distributions. “Vanguard currently does not generate ROC to artificially maintain stable or index-equivalent yields. We have heard a variety of opinions from individual investors, financial advisors, and analysts regarding the preference for yield and ROC considerations, with no clear consensus.”

For what it’s worth, I tend to agree with Vanguard’s position. If you rely on the income from your REIT investments for spending money, then some return of capital would be welcome. But if you’re investing for long-term growth (and that includes anyone holding REITs in an RRSP), the additional yield is a nuisance that simply results in idle cash building up in your account.

Go with the flow

The other reason for VRE’s relatively low yield is probably temporary. When a fund sees large inflows shortly before a distribution date, the amount paid out to unitholders can be diluted. This can affect any investment fund, but the impact is likely to be highest when a new fund is small but growing rapidly. And as Hoffman says, “VRE has grown 470% in the 12 months ending November 2013, most of which is due to cash flow.”

To understand this idea, imagine an ETF has $10 million in assets, consisting of 500,000 units with a net asset value of $20 each. Now assume in a given month the fund receives $20,000 in dividends, which increases the NAV to $20.04. On the next distribution date, investors in the fund would expect a distribution of $0.04 per unit, after which the unit price should fall back to $20.

But let’s say that before the distribution date the ETF sees a huge inflow of new money, which leads to the creation of another 500,000 new units. Now the fund must distribute its $20,000 in dividends among twice as many shares, resulting in a payout of only $0.02 per share.

Before you cry foul, understand that your total return is not affected. “With a lower distribution, there is a correspondingly lower reduction in the NAV,” Hoffman explains, “so in this context investor returns are not harmed.” In the example above, the NAV would fall to just $20.02 after the two-cent distribution. The end result for investors is the same as it would have been without the inflow of new money.

My thanks to David Hoffman and Vanguard for explaining these ideas. Even if you don’t hold real estate in your portfolio, there are valuable lessons here for anyone making ETF comparisons.


  1. Richard December 19, 2013 at 9:34 am

    I currently use ZRE, but now I like the thinking behind VRE as outlined here. Unfortunately it just outperformed the others so it’s less likely that it will repeat that feat right away. I’ll have to keep watching this and see if it’s worth switching.

  2. Cybamuse December 19, 2013 at 12:16 pm

    I must say, for those who don’t have a spare $20k or more or to buy any one individual ETF’s it is a nuisance with respect to setting up DRIPs – if the dividend payout isn’t enough to buy whole shares in the ETF, then all I get is cash and no extra share’s. And with iShares and BMO paying monthly for many of their ETFs, that means unless you have approximately 300 or more shares in the ETF, then you won’t be able to reinvest the dividend – resulting in idle cash in the brokerage account.

    Something for the new investor to think about when they are setting up their portfolio with less than (say) $75k…

  3. Canadian Couch Potato December 19, 2013 at 12:30 pm

    @Cybamuse: I agree that the monthly distributions are mostly a pain for long-term investors. This may be of interest:

  4. Al December 19, 2013 at 12:58 pm

    Would it therefore make any sense to divide real estate 50/50 between ZRE and VRE or is that needlessly complicating the issue?

  5. Canadian Couch Potato December 19, 2013 at 1:06 pm

    @Al: I would definitely say that is needlessly complicating the issue. In a large portfolio it may indeed make sense to split the REIT holding, but I would be more inclined to go half Canadian and half global.

  6. Brian G December 19, 2013 at 3:11 pm

    “We generally pay the income as it is earned”
    “Vanguard currently does not generate ROC to artificially maintain stable or index-equivalent yields.” – David Hoffman, Vanguard

    This is great!!! But I hate how he used the words “generally” and “currently”. :( I would switch to using more Vanguard ETFs if they would make this a policy across the board.

    Hey Vanguard, are you listening? Live your name and be different and put your investors first. :)

  7. David L December 19, 2013 at 4:53 pm

    Thanks for the explanation about VRE’s low yield. Here I was complaining why VRE has such a low yield comparing to ZRE, and I was about to move into ZRE when this article showed up.

  8. My Own Advisor December 19, 2013 at 6:09 pm

    Excellent explanation.

    I think REITs definitely have a place in a portfolio, close to 10% or so in mine, but I’m more inclined over time to debundle the REIT and own 4-5 holdings outright, including RioCan, HR.UN, Calloway and Dundee to name a few.


  9. Que December 19, 2013 at 6:40 pm

    @Dan: How much do you think these large inflows and growth (470%) of VRE has helped boost the returns of Brookfield and FirstService? Que

  10. Michael December 19, 2013 at 7:55 pm

    I was just asking about the low yield of VRE in your recent post, thank you for the detailed explanation! I didn’t realize that the unique holdings (i.e. Brookfield) where contributing to the better performance and lower yield.

  11. Canadian Couch Potato December 19, 2013 at 10:40 pm

    @Que: VRE played no role whatsoever in the performance of any of its holdings. VRE is a $28 million fund and Brookfield has a market cap of $10.4 billion. FirstService is a smaller company ($1.6 billion), but VRE’s share of that is about $840,000, or 0.05%.

  12. sleepydoc December 20, 2013 at 12:12 am

    Another great post! As I recall, your model portfolios include the equal weight option ZRE, as the number of holdings available in the Canadian REIT sector is small. I’ve also considered it to be a “small cap tilt” in this sector. I think in a previous post you’ve also mentioned that the recent performance of VRE is likely a blip and that it suffers from too much concentration like XRE – thus would stick with ZRE in the model portfolios

    Do you think the inclusion of REISs in VRE has a diversification benefit? I would assume that the correlations between REISs and REITs is likely very high, and that the percentage of REISs including too low to make a meaningful difference….

  13. Smithson December 20, 2013 at 1:04 am

    One thing I don’t understand about XRE and ZRE is why their return of capital is so high. In some years, ROC makes up more than 50% of their distributions. I understand that XRE and ZRE may want to smooth out their monthly distributions, but I don’t think it requires that much ROC. If I invest in a REIT ETF, I want them to invest in REITs – I don’t want them to turn around and give me my money back. I think I prefer the way VRE handles distributions.

  14. Nathan December 20, 2013 at 2:07 am

    @Smithson: Given that a couple of commentors in this thread alone were ready to switch to ZRE for its “higher yield”, and CCP readers are probably some of the most knowledgeable retail investors out there, that seems like good reason for them to juice the yield with ROC. I certainly agree that it’s annoying and unnecessary though! Would be even more annoying in a foreign fund though, since you would have to pay taxes on that ROC too.

  15. Canadian Couch Potato December 20, 2013 at 7:43 am

    @sleepydoc (and others): I hope I this post didn’t imply that I think VRE is innately superior to other REIT ETFs. I was simply trying to explain why it has outperformed in 2013. If you look at my older Under the Hood post, you will see its index has actually underperformed over the last several years. There will be a lot of variance between these three ETFs because they are built very differently. That’s not good or bad, it’s just a fact, and I wanted investors to understand that.

    In theory the addition of REISs should provide more diversification, but in the case of VRE, it’s really one company that is moving the needle, which is not ideal diversification.

    @Smithson: I’m going to look more deeply into this, but I was recently speaking with someone at BMO who explained there are actually two different types of ROC in a REIT fund. Many REITs actually distribute ROC themselves as a tax strategy: it allows them to claim capital cost allowance (depreciation) on their properties. If the ETF then flows this through to unitholders, that’s considered “good ROC.” It’s distinct from “bad ROC,” which is simply giving investors their own money back. This blogger explains the idea in more detail:

    Overall I would suggest that you choose your REIT ETF based primarily on its strategy, not its distribution policy.

  16. Al December 20, 2013 at 9:55 am

    How does one get foreign RE exposure ?

  17. Smithson December 20, 2013 at 10:42 am

    @CCP: Thanks for the article. Is there a way of knowing what the ratio is between “good ROC” and “bad ROC” for a given ETF?

    @Nathan: I have noticed that REIT ETFs are not the only ETFs that “juice” their yields with ROC – some dividend ETFs also do this. Like you, I suspect that this is done to make the ETFs more attractive to yield investors.

  18. Canadian Couch Potato December 20, 2013 at 11:23 am

    @Al: There are several US and global REIT ETFs listed on the US exchanges. There is one in Canada (CGR), but it’s quite expensive and tax-inefficient.

    @Smithson: Great question, and I’m not sure of the answer. You may be able to find this in the annual reports, but I’m not sure. It’s on my list of things of thinks to check out.

  19. Tristan December 20, 2013 at 12:06 pm

    @Nathan: Why do you have to pay tax on ROC from a foreign fund?

  20. Canadian Couch Potato December 20, 2013 at 12:36 pm

    @Tristan: Income from foreign investments is not characterized as interest, dividends, capital gains or return of capital as it is on the T-slips you get when you hold Canadian investments. It is all characterized as “foreign income” and is fully taxable.

    The good news is this is largely a moot point: US ETFs don’t seem to distribute ROC very often. Certainly the broad-based equity funds never do. REIT ETFs may do so, however, so it is usually best to hold them in an RRSP.

  21. Adam December 20, 2013 at 1:31 pm

    Hi Dan,

    Are there foreign withholding taxes for CGR? Which account is this best held in?


  22. Canadian Couch Potato December 20, 2013 at 1:55 pm

    @Alan: Yes, foreign withholding taxes would apply with CGR. This blog post may be of interest:

  23. Dennis E December 20, 2013 at 7:05 pm

    Dan, thanks for the explanation of VRE’s poor yield. After posing this question in a previous blog post, I tried to contact Vanguard Canada to get an explanation. One Vanguard representative gave me the brush-off by stating that they are not allowed to talk to mere mortal investors – only financial advisors. But, another Vanguard representative was kind enough to give me the short version of what you have outlined here. Apparently he didn’t get the memo about not talking to strangers.

  24. None December 21, 2013 at 12:15 am

    Are you sure it’s not just a timing thing? I just happen to get my potato up and going when VRE happened to be close to its 52-week high and I’m still down 10%. Blurg.

    Oh well, equities have done great so I’m on course to make 5% this year so I’m content with that.

  25. David L December 21, 2013 at 2:21 am

    Just came upon this gem in the WSJ:

    “You should own REITs because you want to diversify some of the risks of stocks and bonds and to combat inflation—not because you are chasing high dividend yields or because you think the hot returns of the past will persist.”

    I have to remind myself that buying REIT ETF is for diversification, not for yield alone.

  26. Richard December 21, 2013 at 11:11 am

    Interesting article David. It mentions the yield on US REITs is 4%, while general stocks (in the S&P 500) are only at 2%. However I recently saw a forecast that predicted share buybacks in the S&P 500 will be 3% next year. That’s not the same as a dividend or ROC for many reasons but if the total amount returned to investors is actually higher in non-REIT stocks that might be another hidden trap.

  27. Jeff G December 23, 2013 at 1:33 pm

    In the past, I heard it was required, or at least preferable, to buy and sell shares in lots of 100. Does this still hold true, of is it fine to buy whatever number of shares?

    For example, could I buy 117 shares of VTI, or should I be buying 100, and putting the extra money in something like TD e-Series US index fund, until I have enough saved up to buy another lot of 100 shares.

  28. Canadian Couch Potato December 23, 2013 at 1:46 pm

    @Jeff G: Trading “odd lots” is rarely a problem. With some thinly traded ETFs you will occasionally see, for example, 100 shares filled at one price and the other 17 filled at a slightly different price. But with a fund like VTI this is never going to be an issue. Just use a limit order and enter whatever number of shares you need.

  29. Martin December 25, 2013 at 11:33 am


    Thanks for the very informative post. This is very timely in my case, as I was going to use part of my upcoming $5,500 TSFA contribution towards a REIT ETF to have more diversification in my CCP portfolio, however, I admit I am uncertain as to whether I should go with a global REIT ETF, a Canadian one, and whether it should be Canadian or U.S. listed? You also mention RRSP as a good place for REITs for long-term investors such as myself, although I thought one of your older posts seemed to indicate that TSFA was the best place to hold REITs? Maybe I am just needlessly complicating the matter too?

    Also, is there somewhere where I can find a list of U.S. and Canadian-listed REIT ETFs with their management fees to compare?

    Thanks all for your input and Merry Christmas.

  30. Canadian Couch Potato December 26, 2013 at 10:42 am

    @Martin: The decision about Canadian versus global REITs is just a personal one. The Canadian REIT market is very small, so if your portfolio is very large it may make sense to diversify with global REITs. The tradeoff is that global REITs carry currency risk and they are usually more expensive when one considers foreign withholding taxes.

    Canadian REITs can be held in a TFSA, but the most tax-efficient way to invest in global REITs is to use a US-listed fund and hold it in an RRSP.

    There are only three Canadian REIT ETFs, so the comparison should be easy: VRE, XRE and ZRE. The MER differences are less important than the differences in strategy:

    The only Canadian-listed ETF of global REITs is CGR. It is comparable to the US-listed RWO.

  31. Derek February 6, 2014 at 6:17 am

    Thanks for the excellent article.

    The one question I have is whether ZRE’s current distribution (>6% in Feb 2014) is sustained by “bad ROC”. I know REITs distribute some income as ROC due to tax deduction strategies (“good” ROC). Presumably all of this is flowed through as distribution income to ETF unitholders. However, does BMO top-up ZRE’s distribution “bad” ROC to accomplish its high yield of 6%?

    I’ve gone over some of ZRE’s financial statements but I can’t quite figure this out. Any insights?

  32. Canadian Couch Potato February 6, 2014 at 8:12 am

    @Derek: To be honest, I’m not sure how one can calculate the good/bad ROC ratio using publicly available financial statements or reports. But here are some links that may help:

  33. Maureen May 16, 2014 at 10:45 am

    in TFSA I bought 379 shares in ZRE at a high $21.16 and have kept because of dividend. My entire rrsp portfolios are small and I am 68. I’m wondering if I should sell and take a loss and put the money into say XIU or VXUS

  34. Canadian Couch Potato May 16, 2014 at 11:19 am

    @Maureen: Selling a an asset class after it has gone down is precisely the opposite of what a long-term index investor should do. If an investor feels that REITs should be part of their portfolio then the correct thing to do would be to rebalance: i.e. buy more of what has gone down in order to bring it back to the target asset allocation.

  35. […] Hi Nelson, I just read your post about Vanguard’s ETFs.  First, I’d like to explain why there’s no contact info for retail investors.  Because of the way in which we are registered in Canada, Vanguard can only make its ETFs available through investment advisors or directly through brokerages.  At the moment, we are prohibited from dealing directly with individual investors. Second, at Vanguard our goal is to give investors the best opportunity to achieve investing success.  All our products are designed with this in mind.  I would suggest you take a look at the following article to get a better understanding of the issues surrounding VRE: […]

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