Co-produced by Stanford Chemist and written by Nick Ackerman
Real estate sits in the second half of what has been a difficult year. The sector as measured by the SPDR Real Estate ETF (XLRE) is off at approx. 14.5% on a YTD basis.
Nuveen Real Estate Income Fund (New York Stock Exchange: JRS) is further off. The downside here is exacerbated by leverage, which results in a fairly high leverage ratio. Moreover, leaning on favorable issues, it had nowhere to offer defense. Fixed-rate preferred investments, like all other types of fixed-income investments, have taken a hit as interest rates have risen due to aggressive Federal Reserve policy.
It’s good to buy when something is cheap. JRS may offer such an opportunity as the fund is also attractively discounted. Since our last update, it looks like the price has gone down to match that discount as well.
The results show that on a total return basis, the fund is down almost as much as the S&P 500. While this isn’t a good benchmark for this REIT and preferred fund, it does give some idea of what’s going on. provides some context.
Interestingly, despite these challenges, the fund has increased its quarterly distribution since its last update.
- 1 year Z-score: -0.42
- Discount: 6.63%
- Dividend Yield: 8.45%
- Expense ratio: 1.29%
- Leverage: 31.02%
- Assets under management: $398 million
- Structure: Perpetual
The investment objective of JRS is “high ordinary income and capital appreciation”. Their intention to achieve this is to invest “principally in income-generating common stock, preferred stock, convertible preferred stock and debt securities issued by real estate companies.” They also more specifically state that “at least 75% of the fund’s assets under management are rated investment grade securities.”
The fund’s leverage is gradually increasing. Unfortunately, it’s not because the fund is performing well and adding more leverage. This is due to the decline since the fund was last refreshed. Previously close to 27.4% leverage is now just over 31%. This is because total assets under management fell from about $526 million to his $398 million.
In fact, it appears that it needed to reduce its borrowing from $144 million at the end of 2021 to $123.4 million. This can cause permanent damage as the market doesn’t have the same amount of capital to put it back in when it rallies.As we saw until July there was a strong rally. That won’t necessarily last, but it’s already highlighted the risks for highly leveraged funds if they eventually have to cut borrowing.
Another risk of leverage is that it is based on 1-month LIBOR plus 0.61%. Higher interest rates will result in higher leverage costs for this fund. This is partially offset by interest rate swaps they have implemented. Including the leverage cost at this time, the total operating expense ratio is 1.68%.
Performance – Discount rates are attractive, but lags behind C&S
Deleveraging seems to be a fairly common feature of the JRS and Nuveen equity funds. Generally, the leverage is just too high. Of course, you are encouraged to do so because it means higher fees.
In the long run, you are not serving them or your shareholders well. Cohen & Steers REIT & Preferred Income (RNP), a fairly similar fund, holds a sizeable number of preferred funds and has outperformed significantly over the past decade. That’s actually the case when the RNP is assigned a higher priority. It doesn’t look like RNP has had to deleverage over the years.
RNP excels on all standard timeframes except 1 year. In that case, JRS is marginally outperforming. Again, this was only the most recent trend shift, with the JRS rising as the top three holdings rose significantly.
This is not to emphasize the under-investment in JRS compared to RNP. I wanted to use this as a way to highlight the consequences of deleveraging. Of course, it’s not just deleveraging that’s having this impact. The portfolio is also different. This brings me to the point of why hold JRS to gain exposure to a wider range of REITs that RNP and its sister funds do not invest in. will always be
In addition to this, JRS discounts are very attractive, while RNP discounts are not necessarily attractive at this time. In fact, RNP is very rich. For the RNP to outperform going forward, it will either have to significantly improve its portfolio performance, or risk underperforming just at a lower valuation.
Distribution – Reyes distribution
JRS has increased its distribution since the fund’s last update. Announced in early March. The fund performed well at the time and hit new lows the following month, most likely before it was forced to deleverage.
But it was a very interesting boost even when it didn’t seem like it was necessary. was totally unexpected. As a holder, the boost is welcome, but in hindsight I’m skeptical that it was a wise choice.
In my last update, I pointed out that the previous report improved NII coverage. At the same time, the Fund relies heavily on capital gains for distributions. This again highlights why this price increase was unusual in my opinion. Even more unusual, over the course of the year, he had a decrease in NII.
Most of the NII the fund received was in the first half of the year. This is one of the problems when trying to extrapolate a semi-annual period to a full 12 months. Semiannually, they received $5,641,728 in his NII. As of now, they only made another $1,507,888 in the second half of the year. It’s a huge drop that I didn’t expect.
The next NII should be even lower as the portfolio is deleveraged and the interest cost of the debt that is still outstanding is higher. That is, all other things being equal. All other things being equal, an actively managed fund is almost guaranteed.
Ultimately, we’re skeptical that this funding was necessary or beneficial to shareholders, as it shows a more uncertain outlook and lower coverage.
JRS is divided primarily into investments in common stock and meaningful allocations to preferred stock. Mostly prefer the $25 as they label it, but the small $1000 sliver is preferred.
What’s interesting here is that it invests in the real estate space rather than being prioritized in the financial sector as other funds often do. Given the name of the fund, it seems pretty apt.
Returning to RNP again as an example, their preferred assignments are heavily devoted to the banking and insurance industry. Preferred exposures are split roughly 50/50 between common and preferred exposures in the RNP. As such, the fund has significant allocations outside of REITs and the real estate market.
As such, JRS is a purer play in the real estate space compared to RNP.
They manage a portfolio of 89 different holdings. It’s well-diversified, but also a narrower range where each position has a little more impact on the fund’s actual outcome. A fund’s performance will improve if the manager chooses the right holdings. If they make the wrong choice, they can actually start degrading their performance.
The industry distribution also shows that residential, office, retail and industrial REITs make up the bulk of the JRS. These are fairly sensitive areas for the economy. This also helps explain some of the fund’s poor performance. I think it’s a more aggressive fund than RNP.
The top three holdings, Public Storage (PSA), Prologis (PLD), and Equinix (EQIX), have shown incredible growth recently. That’s what brought up his NAV and price for JRS.
PSA looks to have dropped significantly, but this is simply a reflection of the $13.15 special being paid for the PS Business acquisition. They held significant stakes in PSB. It will reappear on August 4th, the dividend payment date.
Three names, PSA, PLD, and EQIX, are also found in RNP’s top holdings. But then other names are different. This repeats the point I tried to make above. I hold both of these her REIT funds for differentiated exposure.
JRS is having a difficult year. This is due to the overall slowdown in the real estate market and broader market impact. Of course, leverage only exacerbates the negative impact, working against the fund. The high leverage makes it look like the fund has deleveraged again. That could slow the fund’s rebound considerably. On the other hand, it is still quite attractively priced. This can lead to relatively strong fund performance compared to peers such as RNP.