RIET - RIET: High-Yield REIT Index ETF Strong 9.5% Yield Risky Holdings

2024-01-08 02:43:27 ET

Summary

• RIET is a REIT index ETF, focusing on high-yield REITs.
• It offers investors a strong 9.1%, with past dividend growth.
• Risks abound.

I covered the Hoya Capital High Dividend Yield ETF ( RIET ), a high-yield REIT index ETF, earlier in the year. In that article, I argued that RIET's strong yield made the fund a buy. Since then, the fund has outperformed broader REIT indexes with marginally lower returns than the S&P 500. Performance has been strong, although volatile.

RIET continues to offer investors a strong 9.5% yield and could see significant capital gains next year as interest rates fall and conditions in the real estate market stabilize. I rate the fund a buy, but it is a very risky, volatile choice, and inappropriate for many investors.

RIET - Basics

• Investment Manager: Hoya Capital
• Underlying Index: Hoya Capital High Dividend Yield Index
• Expense Ratio: 0.50%
• Dividend Yield: 9.50%

RIET - Index and Portfolio

RIET is a REIT index ETF, tracking the Hoya Capital High Dividend Yield Index. It is a somewhat extensive index. Simplifying things, the index includes 100 high-yield REITs, encompassing common and preferred stocks, as well as mREITs. There are sub-asset classes, sectors, and size caps/floors to ensure diversification. Preferreds have weights of 0.33%, other asset class weights of 1.2-1.5%.

From looking through the fund's index methodology, it seems unnecessarily complex, with lots of moving parts. This isn't a significant issue, although it does make it somewhat difficult to analyze the fund.

RIET's weight caps and floors ensure a reasonably well-diversified portfolio, with the fund investing in 100 securities from all relevant property sectors.

Concentration is quite low too, with the fund targeting a 15.0% weight for its top ten holdings, currently at 16.5%.

RIET's portfolio includes several mREITs, which are basically leveraged mREIT plays. Some, perhaps most, mREITs are excessively risky investments, due to excessive leverage. For these securities, significant capital losses and distribution cuts are common, sometimes inevitable. mREITs account for around 25.0% of the fund's current holdings, although figures do vary.

In my opinion, RIET's mREIT exposure is not excessive, but it is quite risky. I strongly considered rating the fund a hold due to these issues. Decided against it as the fund does focus on normal REITs, leans towards higher-quality holdings in other areas, and owing to its reasonable performance track record.

RIET - Dividend Analysis

RIET's most significant benefit is its strong 9.5% yield. It is a strong yield on an absolute basis, and much higher than that of equities, REITs, bonds, and most major asset classes.

RIET does yield a bit less than some of the highest-yielding asset classes and investments, including BDCs, mREITs, and CEFs.

RIET's dividends have seen modest growth since inception in late 2021, growing 2.4% these past twelve months. There have been no other dividend hikes or cuts in the fund's history. Although growth has been quite low, the fund's starting yield is high, so even low growth can be quite impactful.

RIET's dividends seem mostly covered by underlying generation of income, as evidenced by the fund's SEC yield. Said metric measures a fund's underlying generation of income, explicitly excluding capital gains, ROC distributions, and the like. RIET's SEC yield stood at 10.0% this past September, compared to a 10.5% distribution yield. As such, RIETs dividends seem mostly covered by underlying generation of income, with a 0.5% gap.

On the other hand, these figures are a bit outdated, so the situation could have changed since. Dividend yields have, in fact, changed, for instance.

In any case, RIET's strong, growing 9.5% yield is a significant benefit for the fund and its shareholders and core to RIET's investment thesis. This is first and foremost an income vehicle, which investors buy for the yield.

RIET - Quick Market Analysis

RIET is a real estate fund, and the real estate industry has been hammered by higher rates these past two years .

Higher mortgage rates meant buying new homes or real estate properties prohibitively expensive, in some cases unprofitable.

Higher treasury and bond rates meant the opportunity cost of real estate investments was higher, decreasing investor demand and activity in these sectors.

Real estate demand, prices, and activity slowed down . REITs were down too, significantly underperforming since early 2022, when the Fed started to hike.

The flip side of the above is that real estate and REITs should outperform as rates decline next year. The market seems to think so too, with REIT indexes and funds outperforming since the rates peaked in November, and after dovish Fed guidance in December.

Federal Reserve cuts should lead to further improvement in real estate markets, benefitting REITs and RIET. Gains are dependent on cuts materializing and markets reacting (somewhat) rationally, neither of which is a given.

RIET - Performance Analysis

RIET's performance track record is overall quite mediocre, if somewhat complicated. The fund has significantly underperformed the S&P 500 since inception, almost entirely due to unfavorable industry conditions. RIET was created in late 2021, a few months before an aggressive, almost unprecedented set of Fed hikes. These led to significant weakness in the real estate industry, leading to underperformance in the entire sector. RIET has underperformed since, but by about the same as broader REIT and mREIT indexes.

Returns were stronger last year, but still much lower than those of the S&P 500.

In my opinion, although RIET's performance track record is somewhat mediocre, this is not a deal-breaker, and I do expect fund performance to improve. Significant underperformance since inception compared to equities is obviously a significant negative, but partly the result of bad timing and weak industry conditions. RIET does not seem to underperform relative to peers, at least not significantly or consistently. Industry conditions stabilized earlier in the year and have improved these past few months. Lower rates will (probably) act as a tailwind next year. Forward-looking returns look strong, in my opinion at least.

Nevertheless, RIET remains a relatively risky, underperforming fund. These are significant negatives, and probably deal-breakers for many investors.

Conclusion

RIET's strong 9.5% yield makes the fund a buy. It remains a very risky, volatile choice, and inappropriate for many investors.

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