One of the biggest problems currently affecting Americans today is the incredibly high inflation rate that pervades the American economy. We can see the extent of this inflation quite clearly by looking at the consumer price index, which claims to measure the price of a basket of goods and services that is regularly purchased by the average American consumer. This chart shows the annual rate of change of the consumer price index during each month of the past 25 years:
Trading Economics
As we can clearly see, the consumer price index has been increasing at well above the 2.00% rate that economists consider to be healthy over most of the past three years. While we have been seeing the rate of change drop off a bit in recent months, there are signs that the rate could begin ticking up again. This is mostly due to energy prices, which have been rising since the start of July and account for 7.5% of the consumer price index. For our purposes today, the important thing is that the cost of living has been rising rapidly and thus diminishing the wealth of many investors in terms of what that wealth can actually purchase. As such, many investors may be seeking options to protect their wealth and ensure that it continues to be able to purchase the same number of goods and services that it always has.
One way to preserve the purchasing power of the wealth that you already possess is to invest it in real estate. This is because real estate shares many of the same characteristics as everything else that increases in price during an inflationary environment. For example, real estate cannot be created out of thin air like fiat currency (and the root cause of inflation is money creation in excess of actual production growth). Rather, real estate requires actual human or mechanical effort to construct or improve. In addition, there is only a limited supply of real estate because land cannot be created as easily as currency. Thus, real estate should be able to serve pretty well as a way to preserve the purchasing power of your wealth.
One way to invest in real estate is to purchase shares of a closed-end fund that specializes in investing in the sector. These funds are unfortunately not very well followed by the financial media and many investment advisors are unfamiliar with them. That can make it difficult to obtain the information that we would really like to have in order to make an informed investment decision. This is a shame because these funds come with the benefit of professional management teams and can employ certain strategies that allow them to boost their returns well beyond that of any of the underlying assets. This is why these funds frequently have among the highest yields that can be obtained anywhere in the market.
In this article, we will discuss the Nuveen Real Estate Income Fund (NYSE:JRS), which as the name implies is a closed-end fund that specializes in real estate investing. The fund boasts a very impressive 9.15% yield at the current price, which is easily enough to turn the head of any income-focused investor. I have discussed this fund before, but that was almost ten months ago so obviously a great many things have changed. This article will focus specifically on those changes as well as provide an updated analysis of the fund’s financial performance. Let us investigate and see if this fund could be a good addition to your portfolio today.
About The Fund
According to the fund’s webpage, the Nuveen Real Estate Income Fund has the stated objective of providing its investors with a high level of current income and capital appreciation. This does not run counter to our thesis of investing in real estate as a way to preserve the purchasing power of our wealth. After all, the capital appreciation component of this objective accomplishes that nicely as the real estate should appreciate at least at the same rate as inflation in the economy. The income provides us with a method to grow our wealth in terms of its real purchasing power. In short, when we rent out a building, the rent payments provide us with income while the value of the building itself should at least appreciate at a similar rate as inflation. Thus, when we sell the real estate, the sale price of the building should at least give us the same real amount of money back and on top of that we have all of the collected rent over the years that covered the maintenance costs and mortgage. We should therefore have more purchasing power at the end of a given period than when we started.
In order to accomplish that scenario as outlined though, the fund needs to be invested in common equity of the real estate. This is because common equity is the only layer of the capital stack that has exposure to the appreciation of the building itself. This fund is certainly doing that to a degree. As we can see here, currently 64.52% of the fund is invested in the common equity of real estate investment trusts and similar companies:
CEFConnect
We do see that 35.48% of the fund is invested in preferred equity and bonds issued by real estate investment trusts and companies. This does not, unfortunately, fit into the real wealth preservation aspect of our thesis nearly as well as common equity. This is because bonds produce no net capital gains over their lifetime. Preferred stock does not either. While it is possible to make some capital gains by trading these securities prior to maturity and taking advantage of the fact that their prices change with interest rate, on net neither bonds nor preferred stocks deliver capital gains over their lifetimes. This is because neither one of these securities has any inherent link with the growth and prosperity of the issuing entity. They are designed so that the only net investment return received is the dividend or coupon payment made by the issuer to the investor.
On the flipside though, preferred stock usually has a higher yield than the common stock of the same company. Thus, the presence of these securities does result in the fund having a somewhat higher income than it would if it were solely invested in the common equity of real estate investment trusts. This can support the wealth preservation aspect of our thesis, as the received income helps to offset the effect of inflation. It is the same thing as if you got a raise at work. The extra money that you receive in your paycheck helps you maintain the same standard of living as you had previously, despite the fact that the price of everything you buy has gone up.
Real estate investment trusts are very popular among income-focused readers here at Seeking Alpha. Thus, many of the largest positions in the fund will undoubtedly be quite familiar even though I have not personally discussed very many of them. Here they are:
Nuveen
There have been quite a few changes since the last time that we looked at the fund. The most notable of these is that Equity Residential (EQR), AvalonBay Communities (AVB), and Public Storage (PSA) have all been removed from the fund’s largest positions and replaced with Welltower (WELL), Digital Realty Trust (DLR), and Kite Realty Group (KRG). In addition, the weightings of several of the securities here have changed significantly but this might simply be caused by one company outperforming another in the market. It does not necessarily indicate that the fund is actively changing securities to change the overall rankings.
The fact that there have been quite a few changes to the fund’s largest positions over the past nine or ten months could be a sign that the fund has a relatively high annual turnover. In fact, the fund’s turnover during 2022 was 58.00%, which is about average for an equity-focused closed-end fund. The reason that this is important is that it costs money to trade stocks or other assets, and these expenses are billed directly to the shareholders of the fund. That can cause a drag on the portfolio’s performance and make management’s job much more difficult. After all, the fund’s managers will need to earn sufficient returns to both cover these added expenses and provide a competitive return to the shareholders. That is a task that very few management teams manage to accomplish on a consistent basis and it usually results in actively-managed funds underperforming their benchmark indices. This one, unfortunately, is not an exception to that rule as it has only returned a 50.78% total return over the past ten years as opposed to 81.08% for the iShares U.S. Real Estate ETF (IYR):
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Admittedly, this is not particularly surprising. After all, the Nuveen fund has on average around 30% to 40% of its portfolio invested in preferred stocks. Preferred stocks do not deliver as high of a return as common equity over long time periods because of their lack of capital gains potential. Thus, this is not really a perfect comparison for the fund. The Nuveen Real Estate Income Fund is sacrificing some total return potential in favor of income.
That does occasionally work in this fund’s favor though. Over the trailing three-year period, the Nuveen Real Estate Income Fund outperformed the real estate index in terms of total return:
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There could be a few potential reasons for this, including the Nuveen fund’s use of leverage to boost its returns. Another reason though is that real estate securities performed very poorly in 2022 as rising interest rates made mortgages much less affordable and reduced the returns on rental real estate. We also saw single-family home prices fall due to weakening demand, as many buyers care more about the monthly mortgage payment than they do about the actual price of the house.
Preferred stock issued by real estate companies is much less affected by these dynamics than the common equity of the same company due to its lack of a link to the financial performance of the issuing company. A preferred stock will pay the same dividend no matter what happens to real estate prices. Thus, in this case, the fact that the preferred securities held up better than the common equity of the fund’s portfolio proved to reduce the losses that it suffered when real estate equities encountered difficulties last year.
Leverage
In the introduction to this article, I stated that closed-end funds like the Nuveen Real Estate Income Fund have the ability to employ certain strategies that have the effect of boosting their yields well beyond that of any of the underlying assets in the portfolio. One of these strategies is the use of leverage. In short, the fund borrows money and then uses that borrowed money to purchase common and preferred equity issued by real estate investment trusts. As long as the purchased securities have a higher total return than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, that will usually be the case.
However, this strategy is not as effective at boosting yields today with borrowing rates at 6.00% as it was eighteen months ago when borrowing rates were essentially nothing. This is because most real estate common equities have yields of less than 6%, meaning that the fund has to depend on sufficient capital appreciation to offset the money that it pays in interest on the borrowed money as it no longer can rely on dividends alone.
The use of debt in this fashion is a double-edged sword because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much leverage because that would expose us to an outsized amount of risk. I generally do not like to see a fund’s leverage exceed a third as a percentage of its assets for this reason.
Fortunately, this fund is fulfilling that requirement today. As of the time of writing, the fund’s levered assets only account for 27.91% of the overall portfolio. Thus, it appears to be striking a reasonable balance between risk and reward.
Distribution Analysis
As mentioned earlier in this article, the primary objective of the Nuveen Real Estate Income Fund is to provide its shareholders with a high level of current income and capital appreciation. In order to achieve this goal, the fund invests in common and preferred securities issued by real estate investment trusts and similar companies. Real estate investment trusts usually have higher yields than most other common equities things in the capital markets due to tax laws that require them to pay out nearly all of their income to the shareholders. The fund purchases these securities and then applies a layer of leverage to boost their effective yields. It then pays out all or nearly all of its investment returns to the shareholders via a distribution.
As such, we can assume that this fund will sport a reasonably high distribution yield. This is certainly the case as the fund pays a quarterly distribution of $0.17 per share ($0.68 per share annually), which gives it a 9.15% yield at the current price. Unfortunately, the fund has not been particularly consistent about its distribution over the years and has changed it numerous times:
CEFConnect
This is something that will probably prove to be a turn-off for those investors that are seeking a safe and secure source of income to use to pay their bills or finance their lifestyles. It is also a worse history than some other real estate closed-end funds, such as the CBRE Global Real Estate Income Fund (IGR), have managed to achieve. The fact that the fund cut its distribution earlier this year is likely to further reduce its appeal to investors, as that event meant that an investor’s portfolio income declined at a time when it is most needed to offset the impact of inflation.
As I have pointed out in the past though, an investor purchasing today does not need to worry about the fund’s past history. This is because they will receive the current distribution at the current yield and will not be affected by any distribution changes that occurred in the past. The most important thing for a buyer today is the fund’s ability to sustain its current distribution. Let us investigate this.
Unfortunately, we do not have an especially recent document that we can consult for the purposes of our analysis. The fund’s most recent financial report corresponds to the full-year period that ended on December 31, 2022. As such, it will not include any information about the fund’s performance so far this year. This is unfortunate, as the real estate sector has generally performed better this year than it did in 2022. This report should still give us a pretty good indication of how well the fund handled the very challenging conditions last year though, and sometimes seeing how something performs during bad periods is far more insightful than seeing its performance during strong markets. This report is also newer than what we had available the last time that we discussed this fund, so that is also a bonus as it will give us an update on the fund’s financial condition.
During the full-year period, the Nuveen Real Estate Income Fund received $14,590,549 in dividends along with $74,590 in interest from the assets in its portfolio. It had no other income, so this gives it a total investment income of $14,665,139 during the period. It paid its expenses out of this amount, which left it with $7,705,983 available for shareholders. As might be expected, that was nowhere close to enough to cover the $24,154,106 that the fund actually paid out in distributions during the period. At first glance, this is likely to be concerning as the fund’s net investment income was clearly insufficient to cover the shareholder distributions.
However, the fund does have other methods that can be employed to earn the money that it needs to cover the distributions. For example, it might have been able to earn some capital gains that can be paid out. As might be expected from the very weak real estate market last year, it failed miserably at that task. The Nuveen Real Estate Income Fund reported net realized losses totaling $12,418,737 and suffered another $118,450,797 net unrealized losses.
Overall, the fund’s assets declined by $147,317,657 after accounting for all inflows and outflows. Clearly, this fund failed to cover its distributions during the period, which explains the distribution cut. It is uncertain at this time how well the fund can cover its new distribution, which is rather unfortunate. We will need to wait until the fund releases an updated semi-annual report to make this determination, which will likely be in a couple of weeks. A more risk-averse investor may want to wait until that report is released before buying shares of the fund.
Valuation
It is always critical that we do not overpay for any assets in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the Nuveen Real Estate Income Fund, the usual way to value it is by looking at the fund’s net asset value. The net asset value of a fund is the total current market value of all of the fund’s assets minus any outstanding debt. It is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.
Ideally, we want to buy shares of a fund when we can obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are purchasing the fund’s assets for less than they are actually worth. This is, fortunately, the case with this fund today. As of August 4, 2023 (the most recent date for which data is available as of the time of writing), the Nuveen Real Estate Income Fund had a net asset value of $8.44 per share but the shares only traded for $7.57 each.
This gives the fund’s shares a 10.31% discount to the net asset value at the current price. That is not as attractive of a price as the 11.45% discount that the shares averaged over the past month, but any double-digit discount is a very reasonable price to pay for the shares of a closed-end fund. Thus, the price looks acceptable today.
Conclusion
In conclusion, real estate should act as a store of value over time, which makes it a reasonable place to park money for an investor that is looking to preserve the real purchasing value of their wealth. The Nuveen Real Estate Income Fund appears to offer a reasonably good way to do that and earn some income at the same time due to the fund’s focus on purchasing the common and preferred equities issued by real estate investment trusts.
The real problem here is that the fund took heavy losses last year as rising rates made certain real estate deals look unattractive and pushed down the price of several companies in the space. The increasing desire for remote work has also proven very challenging for office space rentals. It might be wise for risk-averse investors to wait for the semi-annual report to ensure that the distribution is covered before purchasing shares of this fund, but the current valuation is quite acceptable.
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