USRT ETF: Specialty REIT Exposures Insulated From Residential Issues

Wide shot of family looking at home for sale with real estate agent

Thomas Barwick

The iShares Core U.S. REIT ETF (NYSEARCA:USRT) has the advantage that its leases grow. Where the US housing reports continue to show declines not only in values but also residential rents, specialty REIT focus continues to be an asset to investors. While asset values even in the specialty REIT space are under technical pressure on account of rising rates and damaged markets for private assets in general, we think in the medium to long term, there is a play in any discounted US issue, as we believe inflation and interest rates are going to be close to peaking. USRT and specialty REITs in general are a buy.

USRT Breakdown

USRT is a really low maintenance portfolio, holding broad REIT exposures value-weighted across US markets. The expense ratio is very low at 0.08%. By sector, specialty REITs represent a lot of the value for US REITs, with industrial, healthcare and retail REITs also being important. Second only to specialty REITs is the residential REIT exposure which is currently under the most pressure.

USRT sectors

Sectoral Exposures (iShares.com)

While residential REITs are currently under the most pressure, since we’re seeing both a reversal in rents and in housing prices according to the most recent November reports, the secular outlook in residential housing demand is typically seen as pretty robust in the US, supported by excellent US demographics.

Otherwise, specialty REIT exposures are robust in terms of their income, as are industrial and healthcare REITs, which benefit from a pretty good composition of long-term lease agreements among the top holdings, all bolstered with rent-hike clauses that guarantee modest rent growth per annum, typically between 3-4%.

Bottom Line

USRT has fallen 22% YTD, and this can mostly be attributed to the higher rates that are putting pressure on cap rates, which have to stand up to higher risk-free rates. But we think that the rate hiking cycle will turn, much like the yield curve predicts.

Because things like rent, which has a massive impact on consumer expectations and wage pressures, are falling, as well as other structural prices like energy (although we think that will be more temporary as Russians boycott the price caps) and logistics, major forces contributing both to current inflation but also inflation expectations are unwinding. Demand has already cooled in the US with the demand for goods certainly falling quite a few points, so with the release of the cost pressures CPI is going to fall to much more manageable rates. While some dislocation in energy markets is going to be a permanent boost to energy prices, and that will likely require a slow down-cycle in rates, markets will anticipate the environment and long-duration financing is going to be unlocked again meaning lots of credit liquidity.

3.32% is a solid yield and there’s no meaningful expense on this ETF. We think that it’s a fair thing to consider real estate assets right now for the diversified investor. It’s a bet on the unlocking of capital markets. Even if rates don’t pause or fall substantially over the next couple of years, just the reduced uncertainty will do a lot for transactions from large real estate allocators.

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