This particular Closed-End Fund (CEF) offers a big 8.3% yield, and it is currently trading at an attractively large discount to its net asset value (NAV). This article explains why this particular CEF presents a very attractive buying opportunity, and we also review the risk factors that investors should be aware of. If you like high-income and less downside risk, this one is worth considering.
Nuveen Real Estate Income Fund (JRS), Yield: 8.3%
The Nuveen Real Estate Income Fund (JRS) invests in income-producing real estate securities, and it is currently on sale. Specifically, here is a look at the price of JRS versus the value of the assets (securities) it holds (i.e. its NAV), and as you can see it is currently trading at an unusually large discount (relative to its NAV).
Specifically, JRS currently trades at a 9.92% discount to its NAV, and this is a 1-year Z-statistic of negative 2.56%. For example, a Z-statistic of magnitude +/- 2 is expected to occur less than 2.25% of the time. Said differently, this is a big discount, which means the share price is very low relative to the assets (and high income) you are getting (more on this later).
Why has JRS Sold-Off, Discount Widened?
The discount is currently so great because investors have overreacted to two things. First, JRS has sold-off on concerns over rising interest rates. Specifically, investors are afraid that as interest rates rise--REITs (such as those that JRS holds) will be particularly challenged because they rely on borrowing to fund growth and the cost of borrowing rises as interest rates rise. There is some truth to this (even though rising rates also means the economy is strengthening, and many of JRS holdings properties will likely do better too). But in our view, JRS investors have overreacted to this risk, and that is somewhat evidenced by the larger magnitude of JRS sell-off relative to a REIT index such as IYR, as shown in the following chart.
There are other important nuances to the performance; for example, the fund has a significant allocation to preferred shares of REITs, which actually generally exhibit significantly lower volatility but also have significant interest rate risk exposure too. However, in our view, the market has overreacted to interest rate concerns, and this fund has sold-off too far.
The other thing that the market seems to have overreacted to is that JRS reduced its quarterly dividend by two cents, and investors often panic when this happens. However, this CEF’s policy is simply to “pass through to its shareholders, each quarter, substantially all REIT distributions it receives.” Therefore the dividend reduction is more a reflection of industry conditions more so than anything management did, especially considering the fund holds a well-diversified portfolio of 85 holdings. For perspective, reference the above charts to see JRS’s relative performance when the dividend reduction was announced at the beginning of March. Not only have the shares sold-off, but the discount to NAV has widened.
Why is JRS a Buy?
We believe JRS currently presents an attractive buying opportunity if you are an income-focused investor for two reasons. First, JRS currently offers very high-income, on sale. Specifically, the individual holdings in the fund pay very high income. However, because JRS is currently trading at a large discount to its NAV, investors are able to buy the individual securities within the fund (i.e. by owning the fund) at a discounted price. JRS is on sale, and investors are buying more yield at a lower price.
Second, if you are risk averse, JRS has less downside risk than the rest of the market. For example, REITs in general have lower betas, which means they tend to rise and fall less along with the overall market. Specifically, when the market sells-off, REITs sell-off less, and JRS also enjoys this characteristic as its beta is well below the market average of 1.0 (JRS’s beta is around only 0.6). Also, high-income investments (such as JRS) generally have less downside risk because when the market sells-off, investors hang on to their high-income payers. JRS tends to be the type of security investors flock to in a “risk-off” environment.
What are the Risks?
If you are going to invest in JRS, there are a few risk factors you should be aware of.
First (and this is common among CEFs), if you are spending JRS’s big dividend payments, then the value of your investment is likely not going to grow nearly as much. For perspective, here is a look at the historical price return and historical total return (price return, plus dividends reinvested) for JRS, and the difference is dramatic.
The above chart also shows the returns for the S&P 500 (SPY), but the point is simply that if you are spending the dividends instead of reinvesting them then the value of your investment, over time, will be very different.
Interest Rate Risk:
Next, investors should be aware of interest rate risk. Specifically, not only are REITs sensitive to interest rate risk, but this fund has a 32.8% allocation to preferred shares, and these shares can be highly sensitive to interest rate risk. Specifically, all else equal, as interest rates rise, the value of fixed rate preferred shares decline. As mentioned earlier, this has likely contributed to the unusually large discount to NAV (i.e. the market has overreacted, out of fear), but it is something for investors to keep on their radar, nonetheless. Also, very importantly, preferred shares are generally far less volatile than the common shares of REITs, and the preferred share allocation in this fund helps reduce the volatility and the downside risks associated with this fund.
Leverage is another risk factor. This fund currently uses 28.4% leverage (borrowed money) which is typical for many CEFs. This leverage helps increase the returns and income in good times, but can increase the downside risks in bad times. The good news is that this fund has already sold-off as evidenced by the big discount to NAV and the recent share price declines, which adds to the attractive upside potential, in our view. And as a reminder REITs (and especially preferred shares of REITs) are low volatility relative to the overall market, so even with the leverage, this fund still has far less downside risk than the overall market (such as the S&P 500) (as measured by beta, for example), plus JRS offers a much higher and very attractive yield for income-focused investors.
Fees are another risk factor for investors to consider. Specifically, this fund charges a management fee of 0.86% (reasonable), and has a total expense ratio of 2.3%. The total expense ratio includes operating expenses and the costs of the leverage. Despite these expenses, we believe the fund is worth considering because of its attractive qualities. Specifically, the benefits of the leverage, discount to NAV, active management, and attractive allocations outweigh the expenses, in our view.
If you are an income-focused investor, JRS is worth considering. Not only does it offer a compelling high yield and attractive investment allocations, but it is currently trading at an unusually large discount to NAV which allows new investors to purchase very high yield at a significantly discounted price. Of course, there is no guarantee that the discount won’t get even bigger, but if you are a long-term income-focused investor looking for very high yield and reduced downside risk, the Nuveen Real Estate Income Fund (JRS) is worth considering.
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