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Investment Thesis
iShares U.S. Real Estate ETF (NYSEARCA:IYR) warrants a hold rating due to multiple mixed factors impacting the fund’s outlook. While the anticipated reduction of U.S. interest rates later in 2024 will provide a tailwind for beaten down REITs, IYR has several negative factors impacting the fund. Although IYR’s top holdings have demonstrated solid growth and profitability, their high valuations will drag IYR down. Additionally, IYR has the highest expense ratio and lowest dividend yield of the top real estate ETFs compared.
Fund Overview and Compared ETFs
IYR is an ETF that generally seeks to track results of the Dow Jones U.S. Real Estate Capped Index, which is composed of U.S. equities within the real estate sector. With its inception in 2000, the fund has 73 holdings and $3.20B in AUM. IYR has the heaviest weights on industrial REITs (13.60%), followed by telecom tower REITs (12.77%) and retail REITs (11.76%).
For comparison purposes, other funds examined are the Vanguard Real Estate ETF (VNQ), the Schwab U.S. REIT ETF (SCHH), the Invesco Active U.S. Real Estate ETF (PSR). VNQ tracks the MSCI U.S. Investable Market Real Estate 25/50 Index with the aim of providing investment income and some growth. VNQ’s heaviest sub-sector weights are retail REITs (13.00%), followed by industrial REITs (12.80%) and telecom tower REITs (12.30%). SCHH tracks the Dow Jones Equity All REIT Capped Index. The fund has similar holdings as IYR and excludes mortgage REITs and hybrid REITs. Finally, PSR selects holdings within the FTSE NAREIT All Equity REITs Index based on metrics including price and risk. It is the least diversified fund of the real estate ETFs compared.
Performance, Expense Ratio, and Dividend Yield
Investors may find REITs attractive because they typically offer a blend between an increase in share price (capital appreciation) and a dividend yield. Looking at performance, IYR has a 10-year compound annual growth rate, or CAGR, of 7.31%. By comparison, VNQ has a 10-year CAGR of 6.37%, SCHH has a 10-year CAGR of 5.06%, and PSR has a 10-year CAGR of 6.60%. Of note, all these real estate ETFs have significantly underperformed the S&P 500 Index over the past 10 years, which has a 10-year CAGR of over 12%. While capital appreciation has been disappointing for many REITs since 2022, we should also look at dividend yield.
10-Year Total Price Return: IYR and Top Peer Real Estate ETFs (Seeking Alpha)
A redeeming quality for real estate funds given the drop in share price is their dividend yield. Unfortunately, IYR has seen the lowest dividend yield of compared funds at only 2.89%. Vanguard’s fund has the highest yield at over 4%. Additionally, IYR has seen a declining dividend yield, with a 5-year dividend CAGR of -1.03%. Another negative factor for IYR is its comparatively high expense ratio. At 0.40%, IYR has the highest expense ratio of top peer real estate funds.
Expense Ratio, AUM, and Dividend Yield Comparison
|
IYR |
VNQ |
SCHH |
PSR |
|
|
Expense Ratio |
0.40% |
0.12% |
0.07% |
0.35% |
|
AUM |
$3.20B |
$62.06B |
$6.25B |
$72.60M |
|
Dividend Yield TTM |
2.89% |
4.14% |
3.39% |
3.10% |
|
Dividend Growth 5 YR CAGR |
-1.03% |
-0.22% |
1.75% |
5.83% |
Source: Seeking Alpha, 19 Feb 24
IYR Holdings and Key Factors Impacting the Fund
IYR is a well-diversified fund with 73 unique holdings. Consequently, IYR is more diversified than both Vanguard and Schwab’s real estate funds and has outperformed both over the past 10 years. IYR, similar to other compared ETFs, has a relatively heavy weight (50.77%) on its top 10 holdings.
Top 10 Holdings for IYR and Compared Real Estate ETFs
|
IYR – 73 holdings |
VNQ – 159 holdings |
SCHH – 122 holdings |
PSR – 28 holdings |
|
PLD – 10.00% |
VRTPX – 13.06% |
PLD – 9.95% |
PLD – 6.92% |
|
AMT – 7.08% |
PLD – 7.65% |
AMT – 7.14% |
O – 6.02% |
|
EQIX – 5.55% |
AMT – 6.25% |
EQIX – 5.65% |
AMT – 5.81% |
|
WELL – 4.23% |
EQIX – 4.68% |
WELL – 4.25% |
CPT – 4.90% |
|
SPG – 4.02% |
CCI – 3.10% |
SPG – 3.95% |
CCI – 4.86% |
|
CCI – 3.86% |
PSA – 3.00% |
CCI – 3.84% |
PSA – 4.86% |
|
PSA – 3.66% |
SPG – 2.81% |
PSA – 3.71% |
REXR – 4.85% |
|
O – 3.58% |
WELL – 2.80% |
DLR – 3.69% |
EXR – 4.84% |
|
DLR – 3.39% |
O – 2.53% |
O – 3.54% |
EQR – 4.80% |
|
CSGP – 2.73% |
DLR – 2.40% |
VICI – 2.50% |
PEAK – 4.77% |
Source: Multiple, compiled by author on 19 Feb 24
IYR has three major factors working for and against the fund looking forward. A major factor working in favor of the fund’s performance is the expected macroeconomic environment. However, looking into IYR’s holdings, the fund has two disadvantages. The first is that multiple of IYR’s top holdings have unfavorable valuations. The second is that several holdings with strong potential and favorable valuations receive a much lower weight. These advantages and disadvantages for the fund are discussed in further detail below.
Positive Factor #1: Declining Interest Rates
A positive factor driving IYR, along with compared real estate funds, is the expected macroeconomic environment. REITs generally tend to do well in two circumstances. The first is the beginning stage of a strong economic growth cycle. The second scenario is when interest rates decline. Most economists are expecting the Federal Reserve to reduce interest rates starting in mid-2024, making this second scenario a reality. Reduced interest rates make it easier for REITs to borrow, conduct development projects, and expand their business. Additionally, REITs are likely to benefit from reduced interest rates because their dividend yields will be comparatively more attractive than fixed-income securities or money market accounts. Therefore, this factor could be a strong propellant for IYR and peer funds in the later part of this year.
Negative Factor #1: Heavy Weight on Several Overvalued Holdings
Despite the positive macroeconomic environment, a negative factor impacting IYR is its strong weight on several REITs that have undesirable valuation factors. The first example is IYR’s 10% weight on Prologis, Inc. (PLD), an industrial REIT. Despite a strong 30.21% YoY cash flow growth, PLD has a YoY Adjusted Funds From Operations, or AFFO, of -0.98%. However, the key downside for PLD is its current unattractive valuation with a 40.54 P/E ratio, 37.8% higher than its sector median. Furthermore, Prologis has an EV/EBITDA that is 60% higher than its sector median.
The second example is IYR’s weight on its #3 holding, Equinix, Inc. (EQIX), a data center REIT. Equinix is another strong holding but not valued favorably. Although Equinix has seen an 8.66% YoY AFFO growth and 20.41% YoY EBITDA growth, the holding has a high P/E ratio of 83.05, over 180% higher than its sector median. Additionally, EQIX only has a 1.99% forward dividend yield, relatively low for a REIT.
Negative Factor #2: Low Weight on Several Favorably Valued Holdings
The second negative factor is IYR’s low weight on holdings with favorable valuations. The first instance of this low weight is Extra Space Storage, Inc. (EXR), a self-storage REIT. EXR is #12 in holdings for IYR at only 2.46% weight. Unlike PLD and EQIX, EXR is favorably valued with a P/E ratio of 24.78, 15.8% lower than its sector median. However, it demonstrates strong fundamentals including a YoY EBITDA growth of 22.01%, a YoY FFO growth of 22.14%, and net income margin of 34%. Additionally, EXR is a strong dividend REIT with a forward yield of 4.58%, 13 years of dividend growth, and a 10-year dividend CAGR of 16.15%.
IYR also has low weight on VICI Properties, Inc. (VICI). This REIT has a large portfolio of gaming and entertainment properties in locations including Las Vegas. VICI has seen strong growth, including an AFFO 5-year CAGR of 39.15% and YoY operating cash flow growth of 20.19%. However, unlike PLD and EQIX, VICI is much more favorable with an 11.92 P/E ratio, 59% lower than its sector median. VICI is IYR’s #11 holding at only 2.51% weight. Additionally, VICI has a solid 5.62% forward dividend yield with a 10.05% 5-year dividend CAGR.
Valuation and Risks to Investors
IYR has a current price of $87.10 at the time of writing this article. This price is near the top of its 52-week range of $72.88 to $92.85 and below its all-time high of $116.14 seen back in December 2021. Over this past year, IYR has seen a negative price return. However, in this time period, IYR has outperformed all other compared real estate funds.
One-Year Performance: IYR and Compared Real Estate Funds (Seeking Alpha)
Despite IYR’s heavy weight on several overvalued holdings, its P/E ratio is lower than all ETFs compared, at 28.59. However, it has the highest P/B ratio at 2.43. Looking forward, declining interest rates will likely have a positive impact on the REIT market at large. However, IYR will likely lag in performance due to its heavy weight on unfavorably valued REITs along with low weight on REITs that are valued favorably.
Valuation Metrics for IYR and Peer Real Estate Funds
|
IYR |
VNQ |
SCHH |
PSR |
|
|
P/E ratio |
28.59 |
35.5 |
34.84 |
41.69 |
|
P/B ratio |
2.43 |
2.3 |
2.26 |
2.37 |
Source: Compiled by Author from Multiple Sources, 19 Feb 24
Real estate holdings have several unique risks for investors, including sensitivity to interest rates and economic growth or decline. Subsequently, all real estate ETFs compared have beta values greater than 1.0, implying volatility greater than the market overall. IYR has a 3-year beta value of 1.11. By comparison, VNQ also has a beta value of 1.11 compared to the Dow Jones U.S. Total Stock Market Index.
Concluding Summary
The expected reduction of interest rates will prove a favorable factor for the REIT funds compared. However, IYR has several top-weighted holdings that have high valuations. Additionally, the fund has low weights on REIT holdings that are favorably valued. Therefore, even if macroeconomic conditions prove favorable, IYR will likely see a sluggish increase in share price. Additionally, compared to top peer real estate funds, IYR currently has the highest expense ratio and lowest dividend yield. Therefore, the fund currently warrants a hold rating.
