USRT: U.S. REITs Appear To Be The Most Reasonable Investment Today (NYSEARCA:USRT) (2024)

(Pexels)

Since 2008, REITs have seen a strong recovery and most crossed back above their 2007 high over the past few months. Property prices have more than recovered in most of the country, and ultra-low interest rates have fueled demand for direct property investment and REITs.

Despite the carnage in the last recession, REITs are generally a defensive investment. More specifically, I would argue they are the most balanced investment. They gain from economic growth, though less than equities. They gain from lower interest rates, though less than bonds. And they gain from higher inflation (if they own land), though less than gold. They are perhaps the only investment that gains slightly from just about everything.

This high level of internal diversification is good for passive long-term investors, but often leaves a lot of money on the table when any of those three economic variables rises at a rapid pace. I would also argue that most REITs have less "inflation hedge" value since most own minimal land. In general, land appreciates buildings do not. As with utilities, it is difficult for landlords to raise rents with the rate of inflation, though most eventually can.

Thus, REITs are generally akin to a "70/30" stock-bond portfolio. To illustrate, take a look at the long-term performance of REITs in blue vs. U.S. equities in red and long-term corporate bonds in yellow:

(Portfolio Visualizer)

You can also see that, despite larger drawdowns, REITs have generally netted the same performance as U.S. equities.

This brings me to the iShares Core U.S. REIT ETF (NYSEARCA:USRT) that generally tracks the blue line above. In my opinion, the ETF is a solid long-term bet and, unlike equities and bonds, is trading near its fair value. I do believe a better risk-reward investment is available among the more value-oriented higher-leverage side of the REIT market, but that USRT is superior to other asset class ETFs for cash-flow-oriented investors.

Deep Dive Into USRT

USRT has been trading since 2007 and is extremely liquid with a $1.7B market cap. It is diversified across all sub-sectors of REITs with specialized (20%), residential (20%), and retail (15%) being the largest categories. This gives the fund adequate diversification but defaults to no alpha generation as would be possible with a more-focused REIT fund like OLD that capitalizes healthcare REITs.

It pays a decent, but historically low yield of 3% after its near-zero 8 bps expense ratio. Take a look at how that dividend yield has fluctuated over time:

Data by YCharts

As you can see, dividend yields on USRT and its peer VNQ are about as low as they have ever been in this bull market. Of course, they were low after 2010 simply because REITs struggled to generate cash flows. Today, they are low because prices are high while cash flows are unchanged.

Speaking of which, the ETF has a weighted average price-to-cash-flow of 16.9X which implies that the dividend yield could be as high as 5.9% if managers halted CAPEX.

How Does USRT Trade to NAV?

To get a better idea of the fundamentals, take a look at this table of the select fundamental statistics for the top 70 REITs in the 150 firm ETF (note, these make up over 75% of AUM):

(Data Source - Unclestock.com)

Here we can see that the fundamentals of large REITs are far from monolithic. Cash-flow yields range from 2-10% and debt ratios from 25-90%. Price-performance also ranges from -50% to 50%, though the median of 15% corresponds almost exactly to the 14.5% YoY price return of USRT.

Cap-rates in the private market are low by historical standards though still reasonable given today's extremely low-rate environment. According to CenterSquare's recent research, they range from 4.7% (apartments) to 5.7% (retail) which is reasonable given the large credit risk difference between the two. We will use 5.2% as our benchmark for a "fair" cap-rate for estimating the ETF's Net-Asset-Value.

Using the above metrics, we get an implied median cap-rate of 4.55% which indicates the fund may be overvalued by around 20% which is higher than I'd like, but still within a reasonable range.

How Strong is the U.S. Property Market?

I would argue that the general U.S. real estate market is in a strong place. Ultra-low financing costs and general mortgage deleveraging have generally removed the risks that used to plague REITs.

As you can see below, U.S. home prices to GDP per capita are back at their long-run average:

Data by YCharts

Not to mention, financing costs are lower today than (essentially) ever before.

That is not to say all of the U.S. looks like it has a healthy property market. In fact, some of the areas where REITs are more concentrated like New York and California have overvalued markets that are showing signs of falling:

Data by YCharts

In USRT you will have some exposure to these markets. Certain REITs like Vornado (VNO), which is highly exposed to the Manhatten market, have already been hit hard by this development. REIT investors looking to generate alpha are probably best off filtering out the West Coast and North East market for REITs and focusing on faster-growing areas like the South East and South West.

The Bottom Line

Overall, USRT is very reasonably valued. It is not undervalued nor is it overvalued. Investors today are getting a fair deal, which is few and far between in the current environment of extremes. Since ultra-high valuation stocks and ultra-low valuation stocks (both of which are plentiful today) tend to deliver highly skewed and often unpredictable results, USRT could be a good choice in building long-term core holdings.

I remain officially neutral on the ETF and personally prefer mortgage REITs (REM) today as I expect strong alpha in that subsection.

That said, I have a bent toward value today and used the implied cap-ratio formula to rank all of the top 70 ETFs. Here is a table of the results from the best value opportunity to worst. Note, those on top usually come with the highest credit risk.

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