If you have spent any time on social media, you have probably seen someone shilling the dream of effortless real estate wealth. The message is always the same: buy a few properties, collect rent checks every month, and build generational passive income.
If someone is promising that outcome with little effort, run! Even when these opportunities are legitimate and not outright scams, the reality of being a landlord is very different from the social media version. Managing rental property is closer to running a small business than collecting a passive paycheck.
You have to deal with maintenance and repairs when something inevitably breaks. Mortgage payments and rising interest costs still have to be covered whether the property is occupied or not. Tenants can fall behind on rent, damage the property, or leave unexpectedly.
In some jurisdictions, eviction processes can take months. In extreme cases, landlords may even deal with squatters or legal disputes. Add property taxes, insurance, renovations, and the occasional emergency repair, and the idea of “passive” income starts to look more like a part-time job.
That does not mean real estate income is a bad idea. It just means the traditional path of directly owning rental properties may not be the best fit for most investors, especially those just starting out. If your goal is exposure to real estate and the income it can generate, there is a simpler option.
You can access real estate through ETFs. The challenge is that real estate ETFs cover a very broad range of sectors, from data centers to cell towers to industrial warehouses. If the goal is to replicate something closer to residential rental income and mortgage-related cash flows, you need to be selective.
Today I am going to highlight two ETFs from iShares that can be combined to create a synthetic rental portfolio. One leans more toward capital appreciation, while the other focuses on maximum yield.
Both pay quarterly distributions, and together they can provide real estate-linked income without the headaches of being a landlord. I will also walk through the allocation I prefer for combining them.
Residential Real Estate Exposure
Our first ETF under the microscope is the iShares Residential and Multisector Real Estate ETF (NYSEMKT:REZ). This fund holds a portfolio of 38 real estate investment trusts, or REITs, tracking the FTSE Nareit All Residential Capped Index. The focus is primarily on residential properties.
Most of the holdings are in multi-residential REITs. Think apartment complexes across major urban areas. The portfolio also includes some exposure to single-family rental homes and mobile home communities.
Because pure residential real estate is still a relatively small slice of the REIT market, the ETF expands into a few related sectors. These include healthcare REITs, which own assets such as long-term care facilities, senior housing, and medical office buildings.
Another interesting component is self-storage REITs. Self-storage properties tend to be less cyclical than many other types of real estate. During economic downturns, people still need storage space. Individuals may downsize their homes, move cities, or store excess belongings during transitions. Businesses may also need temporary storage for equipment or inventory.
One of the reasons I like REZ is what it leaves out. The fund avoids large allocations to commercial office properties, which are still dealing with elevated vacancy rates following the shift toward remote and hybrid work after COVID-19. It also excludes heavy exposure to industrial REITs. While warehouse and distribution center properties have benefited from the growth of e-commerce, they can be more cyclical and sensitive to broader economic activity.
In terms of income, REZ is not the highest-yielding real estate ETF, but it offers a respectable payout. As of March 6, the ETF shows a 30-day SEC yield of about 2.5%. Over the past three years, with distributions reinvested before taxes, the ETF has delivered an annualized total return of 9.46%. REZ carries an expense ratio of 0.48%.
Mortgage Real Estate Exposure
Our high-yield complement to REZ is the iShares Mortgage Real Estate ETF (NYSEMKT:REM). This ETF tracks the FTSE Nareit All Mortgage Capped Index and holds 33 companies. The key distinction is that these are not traditional equity REITs. Instead, they are mortgage REITs.
Equity REITs typically own and operate physical properties such as apartments, office buildings, or shopping centers. Mortgage REITs work differently. Rather than owning properties, they function more like investment firms that borrow money to invest in mortgage-backed securities.
Most mortgage REITs operate using what is known as a spread trade. They borrow funds at short-term interest rates and use that capital to invest in longer-dated mortgage-backed securities that offer higher yields.
The difference between the borrowing cost and the yield on those securities becomes the firm’s profit margin. To enhance returns, these companies often use leverage. Borrowed capital allows them to hold larger portfolios of mortgage securities, which can significantly increase the income generated.
The trade-off is that this structure is very sensitive to interest rates. When borrowing costs rise or the spread between short-term and long-term rates narrows, mortgage REIT profitability can fall quickly. That sensitivity also shows up in the price performance of the sector. For example, during the sharp rate hikes of 2022, REM declined 27.45%.
However, investors who can tolerate that volatility are compensated with significantly higher income. Because the underlying companies generate income from leveraged mortgage portfolios, the ETF delivers a much higher yield than most equity REIT funds. As of March 6, REM shows a 30-day SEC yield of about 9.32%. The expense ratio is identical to REZ at 0.48%.
How to Put the Portfolio Together
You can combine these two ETFs in any proportion that fits your income goals and risk tolerance. However, my personal preference is to keep a smaller allocation to REM because of how volatile mortgage REITs can be.
One way to quantify that risk is by looking at historical volatility. Over the past three years, REM has shown a standard deviation of about 19.72%. By comparison, REZ has been somewhat more stable with a standard deviation of 16.36%.
That difference may not look massive on paper, but it reflects the underlying reality that mortgage REITs are much more sensitive to interest rate movements and credit market conditions. For that reason, I prefer to size REM as the smaller component of the portfolio. Even at a lower allocation, its significantly higher yield still contributes meaningfully to the overall income.
A simple approach would be a 75% allocation to REZ and 25% to REM. That gives you the majority of your exposure through equity REITs that own physical residential properties and related assets, while a smaller portion of the portfolio captures the higher yield potential from mortgage REITs.
Using the current 30-day SEC yields as of writing, a 75/25 allocation between REZ/REM produces a weighted average yield of roughly 4.2%. It is important to remember that this figure is before taxes. The after-tax yield will vary depending on the type of account you hold the ETFs in and your individual tax bracket.
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