iShares U.S. Real Estate ETF: Hot Market, Stable Cash Flows (NYSEARCA:IYR)

Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. – Warren Buffett

The iShares U.S. Real Estate ETF (IYR) invests in the United States’ public equity markets in stocks of companies operating across real estate sectors. The fund invests in growth and value stocks of companies across diversified market capitalization, as it seeks to track the performance of the Dow Jones US Real Estate Index. The index is designed to track the performance of real estate investment trusts (REIT) and other companies that invest directly or indirectly in real estate through development, management, or ownership, including property agencies.

The fund generally targets to invest at least 90% of its assets in securities of the underlying index and depositary receipts representing securities of the underlying index. The underlying fund measures the real estate sector’s performance of the US equity market and may include large-, mid- or small-capitalization companies.

The fund price started to fall from its pre-pandemic high of $100.21 in February of 2020. Once the market crash was initiated, thanks to the pandemic-induced economic lockdown, the price fell to its lowest of $57.84 in March 2020. Subsequently, the price recovered to a post-crash high of $86.82, staying range-bound between $75 and $85 to settle at its current price just under $85.

Comparing the total return charts of the fund and the S&P 500 shows a contrasting picture. The fund’s total return in the last year has consistently been lower than the total return provided to investors by the S&P 500. IYR’s current total return comes in at -4.63%, while the total return of the S&P 500 (SPY) has been in positive territory by 16.85% as of November 11.

Specialized REITs have contributed the most to the fund’s return, being by far the largest component of the fund’s investment allocation. With communications infrastructure, companies such as data center providers and cell tower owners and operators, which are considered essential businesses and continued operations amid pandemic lockdown mandates, were less affected by the coronavirus-related disruption. This has allowed the ETF to perform better than other REITs like retail and office.

Residential REITs were the best performer; however, being a smaller part of the portfolio had less impact than specialized REITs. Earlier this year, the Fed lowered rates to virtually zero. Mortgage rates – which are tied to the treasury market – followed suit. Due to this, 15-year and 30-year mortgage rates now stand at their lowest levels in five years. This has supported and even boosted housing demand, especially the need for multi-family housing schemes, an area where residential REITs specialize as property managers. Expect this trend to continue primarily due to the low cost of credit.

Additionally, Congress’s stimulus packages have also helped Americans with making rent payments, where they have faced a shortfall. Another factor leading to the increased demand has been families’ move to suburbia, seeking to escape the recent breakdown in the law and order situation in cities with ongoing protests relating to alleged deaths of people by police. That demand has combined with the lowest mortgage rates on record, which enabled American households to afford significantly higher-priced homes.

This combination of factors has produced a surging market for new homes in the US in 2020. That market provides a tailwind for the nation’s economy and its recovery from the worst of the coronavirus recession.

Healthcare REITs have also seen a boom as healthcare facilities have seen increased demand due to the coronavirus, growing volumes of patients seeking treatment, and hospitalization, helping generate more revenues.

The dividend payout has not seen a consistently increasing trend. But, as would be expected from a cash flow stable real estate portfolio, the dividend has been steady with it staying well north of $2.00 over the past five years, at least.

The dividend yield has been healthy, with an offering of 3.07%, where the market has seen a yield range of between 1.5% and 2.00%. The latest payout has been near $2.50. However, the five-year compounded annual growth rate has been less than impressive, standing at 0.18%, explained by the dividend payout trend line we analyzed previously.

Risks

The US real estate sector faces political risks as a change in the political landscape can significantly change the tax picture and significantly affect the sector’s profitability. The most significant risk in the immediate future could be tax law changes in the coming years, especially for the commercial real estate sector affected most badly by the coronavirus pandemic.

With businesses shut down and with offices emptied, the commercial real estate sector has tanked with property values falling, falling rents, and more tenants waiting to get out of their leases as more employees work from home rather than the office.

Investor Takeaways

Even with the commercial real estate decline, the overall real estate market shows substantial strength and represents an investment opportunity. The residential real estate segments have been boosted by the decrease in interest rates (which show no signs of rising anywhere soon) to near-zero rates, leading to high demand for mortgages for higher-priced houses. This has also made the acquisition of new management properties through loans a lot cheaper for REITs.

Moreover, real estate used to support communication infrastructure has withstood the tumult as communication networks are essential to a functioning economy and have only increased with the demands being placed on it by work-from-home employees.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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