ETF Teardown: The Best REITs

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool. ETFs hold a collection of stocks that share certain elements in common, so if investors want to capitalize on opportunities in real estate markets, for example, they can turn to the iShares Dow Jones US Real Estate (AMEX:IYR) ETF, which invests in a representative sample of the Dow Jones U.S. Real Estate index.

But since this ETF invests in a number of real estate investment trust (REIT) stocks, it gives investors a broad diversity that also limits their upside. For an investor who was, say, really hip to hotel development but cold on residential properties, this ETF wouldn't fit the bill.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best of what the real estate sector has to offer, and we'll flag some high-risk areas as well. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, any of the 4,700 rated stocks that are profiled in CAPS can be "tagged" with a descriptor that groups the company with others that share a certain quality.

Individual investors have shown significant interest in real estate investments in recent years, a trend that's led to the creation of hundreds of REITs focused on specific real estate sectors. In CAPS, there are a number of REIT tags to choose from, including "REIT -- Hotel/Motel," "REIT -- Retail," and "REIT -- Healthcare Facilities." Looking across these tags, we find hundreds of REITs that trade on American exchanges and show varied performance as a group. For instance, the group tagged under "REIT -- Residential" has risen 8% in the past year, compared with the 17.1% gain in the collective group of hotel/motel REITs.

To get a sense of which companies the CAPS community thinks are the best opportunities in real estate today -- and which they recommend staying away from -- we can sort any of these lists by their CAPS star rank, denoted by one to five stars, with five being the best. Each of the individual companies can then be viewed for exactly who -- from Wall Street to Main Street -- is bullish or bearish on the company and why.

Down to the nitty-gritty
Here's a sampling of some of the favored -- and not-so-favored -- REIT stocks our screen pulled up today.

Millions of baby boomers are sending investors scrambling to all corners of the market, in search of companies poised to profit from the aging demographic. Real estate is no exception, and the trend has made Motley Fool Income Investor recommendation Health Care REIT a popular holding for investors. The aggregator of senior housing and health-care facilities has been taking on more debt and snapping up properties, with one recent acquisition including a $400 million convertible-notes offering. The company is aggressively building out a portfolio of properties ahead of competitors Ventas (NYSE:VTR) and Healthcare Realty in hopes of cashing in on the increased medical and assisted-living needs of the future.

Even though debt on the balance sheet comes in at 75% of Health Care REIT's market cap, CAPS investors largely think the leverage for investment in new properties is worth the risk. A dividend yield of 6.7% and a diversification into medical office properties with a recent acquisition of Windrose Medical Properties are the icing on the baby boomer cake. It's all reason enough for 120 out of 122 CAPS investors to give a bullish rating to Health Care REIT.

While investors favor REITs that are both tightly focused on niches and widely diversified, those same investors can fail to find much enthusiasm for certain shares, for either fundamental or macroeconomic reasons. One example, Boston Properties, ranks low with CAPS investors because of its focus on high-end office space in top markets such as New York, Boston, and San Francisco. Investing in premium properties is a good thing during years of economic expansion, when demand for prime office space thrives. But it is more of a concern when investors believe the larger economy is losing steam -- since premium rental space tends to be the hardest hit when demand slows.

Some CAPS investors are concerned that Boston Properties, like many other REITs, will fall victim to a softening residential real estate market. Should consumers start to hold their wallets and purses a little tighter, businesses will eventually feel the pressure and react accordingly. If so, some executives might think twice about leasing that pricey Manhattan loft they've been eyeing. CAPS investors are thinking twice about Boston Properties as well, with more than 50% of All-Star stock pickers believing the REIT will underperform the S&P.

You can lead a horse to water ...
Plucking individual stocks from a diverse sector such as real estate is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies rather than take a recommendation. After all, even the best stock pickers can be horribly wrong on a stock.

So, do you agree that health-care-facility REITs are the best places to invest? Or are retail REITs a better play? Give your own opinion in Motley Fool CAPS.

Several REITs have made the cut in our Motley Fool Income Investor service for their high yield and income potential. To learn more about companies that will pay you to hold shares, check out a free 30-day trial of the service.  

Fool contributor Dave Mock loves doing the teardown part -- it's the put-back-together part he hates. He owns no shares of companies mentioned here. Health Care REIT is an Income Investor recommendation. Dave is the author of The Qualcomm Equation. The Fool has a disclosure policy.