Income Investors are often attracted to real estate securities because they offer big steady yields. For example, the real estate sector ETF (XLRE) offers an attractive 4.1% dividend yield. And considering the sector had a relatively poor 2016 (XLRE was up only 4.9% versus up 13.4% for the S&P 500 ETF), it’s even more attractive in 2017 from a contrarian standpoint. However, if you are a mature income-focused investor there are other attractive ways to play the sector. This article reviews a compelling, real estate Closed-End Fund (CEF) that offers a big 9.2% yield (paid quarterly), it will benefit handsomely as the sector rebounds, and it currently trades at an attractive 6% discount to its net asset value (NAV).
Nuveen Real Estate Income Fund (JRS):
The Nuveen Real Estate Income Fund is a closed-end fund (CEF) that offers a big 9.2% distribution yield. As a CEF, it trades on an exchange (NYSE), and its price fluctuates throughout the course of each trading day. However, because it’s a CEF, its price can deviate significantly (discount or premium) relative to its net asset value (the aggregate market value of the individual holdings within the fund) thereby creating some very attractive opportunities (more on JRS’s discounted price later).
The objective of JRS is to seek high current income and capital appreciation through investments in income producing common stocks, preferred stocks and debt securities issued by real estate companies. For reference, here is a breakdown of the fund’s current holdings.
Important to note, the majority of the “Other” category is leverage (the fund’s current leverage ratio is 30.1%, more on leverage later). And for reference, here is a recent snapshot of the fund’s top holdings.
Sources of Income:
Considering the fund holds primarily real estate securities (mostly REITs), you may be wondering how it is able to pay out a 9.2% distribution yield when REITs yield, on average, only 4.1% as measured by the Real Estate Sector ETF (XLRE). The answer is a combination of dividends/income, capital gains, leverage, and in rare cases a return of capital. Specifically, the 9.2% yield is reasonable if we assume REITs will deliver a long-term total return (dividends plus price appreciation) of 7.3% (this is the 2017, 10 to 15 year estimate, provided by JP Morgan). More specifically, if this 7.3% return is levered by 1.3x (the fund’s leverage ratio) then the gains available for distribution actually exceed the 9.2% payout (1.3x is a conservative leverage ratio, and is limited by regulation from going much higher). Further, considering the fund trades at a discount to NAV, and considering publicly traded real estate is an attractive contrarian play right now, we’re comfortable that the fund can comfortably maintain this healthy 9.2% payout ratio.
And for reference, this table from Nuveen shows the recent breakdown of distribution income sources.
As mentioned previously, publicly traded real estate securities are an attractive contrarian play right now considering they’ve recently underperformed the market as measured by the real estate sector ETF (XLRE) versus the S&P 500. For your consideration, the following table shows the recent performance (through yesterday) of 40 different sector and industry ETFs, including XLRE.
Discount to NAV:
The Nuveen Real Estate Income CEF currently trades at an attractive 6.02% discount to its net asset (see the following chart for recent history).
The discount may be due to a variety of factors including overly fearful investors selling off real estate in general out of fear of rising interest rates and as they rotated into other sectors following the US election. And while there is no guarantee this fund will ever erase the discount (it could actually increase) we’re far more comfortable buying JRS at a discount than if it were trading at a premium.
Investing in CEFs and in JRS in particular involves risks that are worth considering. For example, the fund uses leverage (i.e. it borrows money). And while the amount of leverage (30%) is conservative and manageable in our view (it’s also near the maximum allowed by regulations designed to keep CEFs safe), it could work against the fund. Specifically, if real estate securities actually decline in value, the declines could be magnified by the leverage depending on how well the Nuveen management team manages it (more information on the management team is available here).
Another big risk factor is the expense ratio which was recently 1.27% (reasonable for a CEF) as shown in the following table.
At Blue Harbinger, we generally despise management fees (because they detract from long-term performance), and we work very hard to eliminate or minimize management fees as much as possible. However, in the case of CEFs, some investors are comfortable paying the fees in exchange for the high income and “sleep well at night” peace of mind that CEFs can offer. Specifically, if you are a mature income-focused investor then it can make sense to pay someone else (in this case Nuveen) to manage a portfolio (in this case JRS) to generate the income you need (i.e. the 9.2% distribution yield). However, if you are a younger investor, still saving for retirement, then we generally do NOT recommend investing in CEFs because you’d be far better off investing in low cost ETFs (such as those listed in our ETF table above) because the money you save on fees (you don’t need the high income yet) will add to the long-term growth and compounding of your nest egg, which can be extremely valuable over a +30 year time horizon.
Overall, we consider the Nuveen Real Estate Income Fund to be an extremely valuable investment opportunity for some investors. Specifically, it passes the bar we set in our recent article How to Pick a Good Closed-End Fund, and we like it specifically because of its discounted price, the contrarian outlook for real estate, and its big sustainable distribution yield. If you are a young person still saving for retirement then this fund is probably NOT for you, but if you are a mature retired (or semi-retired) investor then the Nuveen Real Estate Income Fund is worth considering for an allocation within your diversified income-focused portfolio.