Not A REIT Fan But Love Income? Here's How IYRI's Strategy Actually Works

The NEOS Real Estate High Income ETF, or IYRI, is built for one clear purpose: to deliver a steady stream of monthly cash. It's an actively managed fund that mostly invests in real estate stocks, but its real engine is a strategy designed to generate high income. The fund's website states its goal is high monthly income with the potential for appreciation. That promise is backed by a yield that looks impressive on paper, with recent distributions around $0.44 per share, which annualizes to roughly a 10.7% yield.

The trade-off is straightforward and built into the fund's mechanics. To generate that high monthly payout, IYRI sells call options on the real estate stocks it owns. This is a classic covered call strategy. The premium income from selling these options boosts the fund's distributions. But there's a catch. By selling the right to buy the stocks at a set price, the fund caps its upside potential. If the real estate market rallies strongly, the fund's gains are limited because it may be forced to sell its holdings at the agreed-upon strike price. In a bull market, this strategy can leave money on the table.

A second, more subtle trade-off is in how the distributions are taxed. The fund's payouts are largely classified as a return of capital. For investors, this can be tax-efficient in the short term because it's not treated as ordinary income. However, it reduces the investor's cost basis in the fund. Think of it like taking cash out of your investment without selling shares; you're lowering your cost, which can increase your capital gains tax bill when you eventually sell. It's a tax-efficient way to get income now, but it's a trade-off that investors need to understand.

The Tax Efficiency Angle: How the 1256 Rule Works

The real tax advantage of IYRI isn't found in the REITs themselves, but in the mechanics of the options strategy that generates its high payouts. The fund's option premiums are classified as income from Section 1256 contracts. This is a specific IRS rule that treats profits and losses from certain standardized options and futures contracts differently from ordinary income.

The key benefit is a favorable blended tax rate. Gains from Section 1256 contracts are taxed at a mix of 60% long-term and 40% short-term capital gains rates. This is a significant difference from the typical tax treatment of REIT dividends, which are usually taxed as ordinary income at much higher rates-up to 37% plus a 3.8% surtax in 2026.

Put simply, the fund's structure uses the ETF wrapper to capture this tax efficiency. The covered call strategy creates the Section 1256 income, and the fund's requirement to distribute most of its taxable income means that portion of the distribution gets this special tax treatment. This is a structural feature of the options overlay, not a perk of owning REITs directly.

For an investor, this means a portion of the high monthly income is taxed more favorably than a standard dividend. It's a built-in advantage that helps boost the after-tax yield, making the fund's income stream more efficient in a taxable account.

The Hidden Cost: Capped Upside and Market Sensitivity

The strategy's Achilles' heel is its performance in a bull market. Covered call ETFs like IYRI are structurally suboptimal because they consistently underperform not only in rising markets due to capped upside, but also during market declines. The fund sells call options on its real estate holdings to generate premium income. This means it agrees to sell those stocks at a set price. When the market rallies, the fund's gains are limited because it may be forced to sell at the agreed-upon strike price, leaving the rest of the upside on the table. In a strong bull market, this creates a clear opportunity cost.

This limitation is reflected in the fund's recent returns. Over the year-to-date period, IYRI has returned 3.13%, which is notably lower than the 4.67% return of the Vanguard Real Estate ETF (VNQ). This underperformance highlights the trade-off: the fund's monthly income is paid for by giving up some of the potential for capital appreciation.

Another critical point is the fund's lack of diversification benefit. IYRI has a correlation coefficient of 0.95 with VNQ. That's extremely high, meaning the fund moves almost perfectly in lockstep with a standard REIT ETF. For an investor seeking to reduce portfolio risk through diversification, this is a major red flag. The fund doesn't offer a different risk/return profile; it simply layers a yield-enhancing strategy on top of the same underlying real estate exposure.

Finally, the tax-efficient income comes with a hidden cost that surfaces years later. The fund's distributions are largely classified as a return of capital. While this can be tax-efficient now, it reduces the investor's cost basis in the fund. Think of it as taking cash out of your investment without selling shares; you're lowering your cost, which can increase your capital gains tax bill when you eventually sell. This is a long-term trade-off that investors must weigh against the immediate appeal of a high monthly payout.

Catalysts and Risks: What Could Make or Break the Yield

The high yield of IYRI is not guaranteed; it depends on a specific market setup. The fund's strategy is built for stability, not a breakout. Its success hinges on real estate markets that are flat or declining. In those conditions, the monthly option premiums provide a cushion, and the fund can outperform a standard REIT ETF. But if the real estate sector enters a strong bull market, the strategy's biggest flaw becomes its downfall. The capped upside from selling call options means the fund will consistently underperform the rally, leaving investors with a lower total return than if they had simply owned the underlying REITs.

The primary risk here is pure opportunity cost. You are paying a premium for that steady income by giving up the full growth potential of the market. As one analysis notes, covered call ETFs consistently underperform not only in rising markets due to capped upside, but also during market declines. This is a structural trade-off, not a temporary hiccup. The fund's recent performance, returning 3.13% year-to-date versus the 4.67% of the Vanguard Real Estate ETF (VNQ), is a clear example of this drag in action.

For investors, the key to navigating this is vigilance. You must monitor the fund's distribution composition. As of the most recent payout, 78% was estimated to be return of capital. This is the tax-efficient engine of the strategy, but it also means your cost basis is being reduced. Over time, this can inflate your capital gains tax bill when you eventually sell. Understanding this mix-how much is real income versus a return of your own investment-is crucial for managing your tax picture and assessing the sustainability of the yield.

The bottom line is that IYRI is a tactical tool, not a passive buy-and-hold. It works best when you expect the real estate sector to be range-bound or weak. If you believe in a powerful, sustained rally for REITs, this fund is likely to disappoint. The high yield is a reward for accepting that capped upside and the long-term tax implications of a return of capital.