SCHH: Generating Steady Long-Term Returns, Investing In The Right REITs

~ by Snehasish Chaudhuri, MBA (Finance).

I covered Schwab U.S. REIT ETF (NYSEARCA:SCHH) during April, 2022, and was bullish about the stock. My primary justification at that time was that I thought investors could expect a decent average price growth with this exchange-traded fund (“ETF”). I also noted that technical indicators indicated a short-term upward price movement. After a gap of nine months, I’d again like to review this fund and find out its investability. To start with, the fund has continued generating low yield, but double-digit total return over the long run. SCHH is trading around $20 and has an extremely low expense ratio of 0.7 percent.

Schwab U.S. REIT ETF is a Volatile Fund and Lacks Diversification

Schwab U.S. REIT ETF is an exchange-traded fund that was launched and is managed by Charles Schwab Investment Management, Inc. It invests in stocks of various types of real estate equity investment trusts (“REITs”) except mortgage REITs and hybrid REITs. The fund seeks to track the performance of the Dow Jones Equity All REIT Capped Index, by using full replication technique. This fund seeks to track Dow Jones Equity All REIT Capped Index, which is composed of U.S. REITs classified as equities. Under normal circumstances, the fund has a policy of investing at least 90 percent of its asset under management (“AUM”) in securities included in the index.

In my last coverage nine months back, I found this fund to be highly volatile, and I mentioned that:

“historically, Schwab U.S. REIT ETF has a very strong and steady performance on an average. But this return has been highly volatile. In only four out of the past ten years, this ETF generated a return in excess of 6.5 percent. But growth in those four years had been remarkable. At the same time, the average (annual) growth rate during the four years between 2015 and 2018 was only 2.3 percent. This extreme volatility is not a very good indicator for this fund. Had this REIT ETF been well diversified, it could have a lower volatility risk.”

Unfortunately, Schwab U.S. REIT ETF is still not well-diversified.

More than 80 percent of SCHH’s investments are in four types of REITs – specialized REITs, residential REITs, retail REITs, and industrial REITs. I can understand low investments in office REITs, as currently these REITs are suffering due to increasing trends in remote-working facilities. However, this fund’s lack of diversification in healthcare REITs, hospitality REITs, diversified REITs, hybrid REITs, and mortgage REITs doesn’t seem to be a wise idea for a REIT fund. In my opinion, healthcare REITs and mortgage REITs are going to immensely benefit in the coming years. Moreover, this fund has a very low turnover ratio of less than 6 percent. That means Schwab U.S. REIT ETF is not going to change the composition of its portfolio in the near future.

Top Holdings of Schwab U.S. REIT ETF Have Performed Well Over the Long Run

SCHH’s top 20 holdings account for more than 60 percent of its AUM of $5.7 billion. Half of these companies are specialized REITs, such as the world’s largest private owner of timberlands – Weyerhaeuser Company (WY), market leading operator of gaming facilities – VICI Properties Inc. (VICI), global leader for storage and information management services – Iron Mountain Inc. (IRM), owner of self-storage facilities – Extra Space Storage Inc. (EXR) and Public Storage (PSA), data center – Equinix, Inc. (EQIX) and Digital Realty Trust (DLR), infrastructure firms – SBA Communications Corporation (SBAC), American Tower Corporation (AMT), and Crown Castle (CCI)

Significant investments are also made in residential REITs like AvalonBay Communities Inc. (AVB), Equity Residential (EQR), Mid-America Apartment Communities Inc. (MAA), Sun Communities Inc. (SUI), Invitation Homes Inc. (INVH), Essex Property Trust Inc. (ESS), etc. However, the largest investment was made in an industrial REIT named Prologis, Inc. (PLD), which consistently accounted for more than 8 percent of SCHH’s portfolio of investments. PLD is the global leader in logistics based real estate properties, focusing primarily on high-barrier, high-growth markets. Another 8 percent of Schwab U.S. REIT ETF is invested in retail REITs such as Simon Property Group, Inc. (SPG), Realty Income Corporation (O), and Kimco Realty Corp. (KIM).

The stocks of specialized REITs have been the best performing ones, both in the short run and long run. Out of the 10 specialized REITs listed above, barring DLR and WY, all other REITs had a price growth in excess of 40 percent during the past 5 years. This is despite the broader market performing poorly during the past two years. Again, during the past three months, barring PSA and EXR, all other stocks had a positive price growth. SPG, PLD, SUI, KIM and O also generated double-digit price growth during these three months. PLD, MAA, SUI, INVH, O, and KIM – all these stocks registered a price growth in excess of 25 percent during the past 5 years. Overall, top holdings of Schwab U.S. REIT ETF performed quite well over the long run, as well as immediate short run.

Investment Thesis

Despite a low yield, Schwab U.S. REIT ETF has consistently generated high total returns over the long run. SCHH has a high AUM and is trading at par with its NAV. The portfolio consists primarily of four types of REITs – specialized REITs, residential REITs, retail REITs, and industrial REITs. Under the current economic condition, specialized REITs and industrial REITs have performed much better than the other REITs. These REITs have suffered the least due to covid-19 pandemic and Russia’s invasion of Ukraine. The reason is simple – the supply-chain disruptions created higher demand for such REITs and due to scarcity of such specific real estate properties, its margins went up.

However, the lack of diversification in healthcare REITs, hospitality REITs, diversified REITs, hybrid REITs, and mortgage REITs makes Schwab U.S. REIT ETF a little susceptible to property-specific risk. Since investors of this fund rely on the total return of this fund, its sustainability is of prime concern. In my opinion, the current level of yield and average total return seems sustainable for two reasons – a) top holdings of SCHH performed quite well over the long run, as well as immediate short run, b) Specialized REITs and industrial REITs are expected to perform much better than the other REITs.

Schwab U.S. REIT ETF thus will be suitable for both income-seeking investors and growth-seeking investors. Thus, I would stick with my bullish view about Schwab U.S. REIT ETF.