There are some excellent exchange-traded funds (ETFs) for dividend investors, and there's a solid case to be made for some high-dividend ETFs, dividend growth ETFs, and other types. But when it comes to my top dividend ETF to buy in 2025 as a long-term investment, the Vanguard Real Estate ETF (VNQ 0.34%) is the clear winner for me.

This is a low-cost index fund that invests in a portfolio of real estate investment trusts, or REITs. REITs are income-focused stocks, but they also have lots of potential to generate market-beating total returns over time. Here's a rundown of what you should know about this ETF, and why 2025 could be a great time to add it to your portfolio.

Why invest in a REIT ETF?

The Vanguard Real Estate ETF tracks a weighted index of REITs. It has a low 0.13% expense ratio and owns about 160 different stocks.

REITs tend to pay dividend yields that are significantly above average. To be classified as REITs, these companies are required to pay at least 90% of their taxable income to shareholders (and in practice, they generally pay more). As a result, the Vanguard Real Estate ETF has a 3.8% yield as of this writing.

Despite the popular misconception, REITs aren't just income investments. In fact, some of the top REITs have long track records of producing market-beating total returns. REITs can also create value for investors in several different ways. For example:

• Property values tend to increase over time. If a REIT's properties increase in value, the intrinsic per-share value of the stock can increase as well.
• Many REITs develop properties from the ground up and can create value in the process. Think of it this way -- if you can spend $8 million to build a property that will be worth $10 million upon completion, you've just created $2 million in value.
• REITs can sell properties at a profit and reinvest the proceeds in new opportunities, a process known as capital recycling.

REITs can also grow their dividends over time. Most commercial real estate leases have annual rent increases, known as escalators, built in.

Solid businesses that are beaten down

Because of the relatively high-rate environment of the past few years, real estate has been one of the worst-performing stock market sectors. However, in many cases, the stock prices of REITs don't accurately reflect their business performance.

For example, Prologis (PLD 0.33%) is the largest component of the Vanguard Real Estate ETF. It invests in industrial properties like warehouses and distribution centers. Prologis' stock price is down by about 33% from its peak reached in early 2022. But over the past three full years, Prologis' core funds from operations (core FFO, the REIT equivalent of "earnings") per share has increased by 34%.

This is just one example and shows how REITs can be beaten down due to interest rates and economic factors, not because there's anything wrong with their businesses.

A winner in a falling-rate environment

To be sure, if the Federal Reserve continues to lower interest rates over the next few years, as most experts believe it will, it could provide a tailwind for many different areas of the stock market. But real estate stocks could be particularly big winners.

The most obvious reason is lower borrowing costs. Just like how most homeowners use a mortgage to help acquire their homes, REITs typically rely on borrowed money to grow their portfolios.

However, the biggest effect is known as "cap rate compression." Commercial property values are derived from a capitalization rate, or cap rate, which tells you a property's net operating income (NOI) as a percentage of its purchase price. For example, a $1 million property with a 7% cap rate would generate $70,000 in NOI annually.

Without turning this into too much of a math lesson, when risk-free interest rates fall, cap rates tend to fall as well. Property values and cap rates have an inverse relationship, so as rates fall, commercial real estate values rise.

To be clear, high-quality REITs can be excellent businesses regardless of what the interest rate environment is doing. But they can perform very well in a falling-rate environment. My general prediction is that the Fed will lower rates several times in both 2025 and 2026, and if that proves accurate, it could be a big catalyst for REITs.