SCHH: A Low-Cost, Indexed REIT ETF For The Long Haul

Summary

• SCHH is a widely diversified, real estate investment trust-focused ETF managed by Charles Schwab.
• The fund tracks the performance of the Dow Jones Equity All REIT Capped Index, weighted towards large capitalization domestic REITs.
• We highlight three key reasons why SCHH is a viable option for REIT exposure.

Vladimir Zakharov/iStock via Getty Images

Introduction

The Schwab U.S. REIT ETF (NYSEARCA:SCHH) is a popular, REIT ETF that has provided diversified exposure to United States Equity REITs for over a decade. With over $6 billion in assets under management, the fund is one of the largest REIT focused ETFs.

Inflation has become the talk of the town recently clocking the highest rate in over three decades. Investors are looking for cover searching for asset classes which can perform under pressure and maintain reasonable valuations. Historically, investors have had a wide variety of options which have outpaced the rate of inflation. However, with recent macroeconomic developments inflation has kicked up significantly and investors are facing a difficult outlook. With the long-term inflation rate above 6%, the situation becomes difficult.

Source: St Louis Fed

With the stock market remaining at all-time highs, due to a combination of strong earnings as well as stretched valuations, investors are now searching for other assets which can provide viable performance. As we have discussed recently, it appears that most fixed income will be inadequate to fight a rate of inflation that's above 6%.

Real assets can alleviate the pressure of inflation. Historically, real estate has presented investors with an opportunity to provide current income in the form of rent collected from tenants, complimented by capital appreciation achieved through rising asset prices (inflation). In times of stress, we often look to other successful investors for guidance. Berkshire Hathaway's Warren Buffett has stressed the importance of real estate in periods on inflation on account of both rent collection and rising prices as an asset.

History has verified these theories as REITs have produced superior performance during times of moderate inflation. Moderate inflation is defined as a rate between 2.5% and 6.9%. Hopefully, we do not enter a period of long-term inflation above 7.00%.

Source: NAREIT

The average investor can do more than just follow in Buffett's footsteps. Investors can access a deep sea of REIT opportunities, each providing their own unique strengths and weaknesses. Alternatively, investors can take on the sector through an indexed approach by investing in funds such as SCHH or the Vanguard Real Estate ETF (VNQ). These cheap funds are managed by some of the most trusted asset managers, providing shareholders with exposure to the highest quality of assets and indexed portfolio construction.

Let's explore some reasons why SCHH is a viable option for broad equity REIT exposure.

Institutional Real Estate Exposure

As we mentioned, SCHH seeks to track the Dow Jones Equity All REIT Capped Index. The fund is large, managing over $6 billion in total assets. The fund casts a wide net, providing exposure to over 100 equity REITs in the United States, weighting heavily towards the largest capitalization companies. The fund does not invest in mortgage REITs, limiting investment to firms that own the underlying assets. Although focused on Real Estate, the fund provides exposure to a variety of sectors including specialized REITs (38.9%), Residential REITs (15.81%), and Industrial REITs (11.7%).

Source: SCHH

The fund's market cap weighting means larger, established firms receive the largest investment. Some investors may view this as a downside given that larger REITs may have trouble growing quickly. However, a portfolio of superior diversification can often come to the rescue during times of stress.

As it stands today, the largest position in the fund is American Tower at 8.64%. AMT is the world's largest REIT by capitalization proving cell tower and data center services across the globe. With an enormous market capitalization, the firm has grown tremendously and outperformed the broader market by a considerable margin. Other top holdings include Prologis (PLD), Public Storage (PSA), and Simon Property Group (SPG). The portfolio is widely diversified as each REIT owns hundreds if not thousands of individual assets.

Source: SCHH

In essence, SCHH provides an indexed approach to real estate, offering investors a means to access real estate investments generally reserved for institutions. Additionally, REIT shareholders benefit from hands-off property management and legal services which eliminate a material amount of liability associated with real estate investing.

SCHH also provides an opportunity to diversify holdings in traditional equity indexes. Given many investors center their portfolio around large capitalization equities, there are ample reasons to look for diversification opportunities. Real estate accounts for only 2.6% of the S&P 500. Meanwhile Information Technology accounts for nearly 28%. This is not surprising given the strong performance of the technology sector, which has led the S&P 500 over three of the last four years. That said, the small real estate allocation leaves investors with an opportunity to make a targeted investment to an under-allocated sector. As we mentioned, REITs offer a viable alternative to traditional real estate investing, offering shareholders the added benefits of a capable professional management team.

Source: S&P Global

Income

SCHH launched in 2011, operating successfully and distributing dividends nicely ever since. The fund has performed well, tracking its benchmark over short and long periods. As we mentioned earlier, REITs offer investors protection against inflation through capital appreciation and rental revenue. The rent portion of the equation translates directly to income for shareholders. Due to tax laws associated with real estate investment trusts, portfolio companies are required to distribute 90% of their taxable income to shareholders. As a result, these real estate firms often provide shareholders with strong distributions. Inflationary environments such as today, these real assets can see their rental streams increase substantially as rents rise across the nation. This added income will be passed through to shareholders in the form of rising dividends.

The income produced by real estate investment trust is superior to the broader equity market. For income investors, these investments can offer a material advantage for people looking for cash flow that can pay bills. Over time, this income has proven its durability as well as its ability to continuously grow. The classic investment model of real estate is a fundamental style of investing. Income-oriented investors should seriously consider adding income producing real assets to their portfolio.

Expenses

Put simply, SCHH offers broad exposure to the U.S. real estate market. The fund is well managed and transparently constructed with weighting towards the largest REITs. Shareholders receive direct ownership of the real assets held in these equity portfolios. With the shares also comes professional management. Obviously, these expenses are built into company operating expenses, but can benefit from their scale. Many of these companies own thousands of assets, so corporate level expenses are spread among a wide portfolio. On a per asset basis, these expenses are often more efficient than hiring a property manager directly.

The fund is managed by Charles Schwab (SCHW). At the fund level, Schwab charges a modest expense ratio of just seven basis points. It's worth noting that these expenses are considerably less than other real estate focused funds. The expense ratio is even cheaper than Vanguard's counterpart, the Vanguard Real Estate ETF.

Fund Name	Expense Ratio
SCHH	0.07%
VNQ	0.12%
IYR	0.41%
USRT	0.08%
XLRE	0.12%
RWR	0.25%
FRI	0.50%

Click to enlarge

Source: Author Using Data From Seeking Alpha

The indexed portfolio construction and best-in-class expense ratio creates a compelling opportunity for long-term investors looking to access real estate.

Conclusion

SCHH is a core fund for investors looking for equity REIT exposure. The fund invests across a wide set of the investible universe, excluding mortgage REITs and hybrid REITs along the way. As a result, investors are purchasing an interest in some of the most desirable real assets with an included layer of professional property management. The REIT model also provides legal protection to shareholders, reducing financial liability. Considering the sizeable assets under management, healthy yield, and rock-bottom expense ratio, it should come as no surprise that SCHH is a popular fund.

Disclosure: I/we have a beneficial long position in the shares of VNQ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.