Written by Nick Ackerman, co-produced by Stanford Chemist.
We last cover Cohen & Steers Real Estate Opportunity and Income Fund (NYSE:RLTY) earlier this year. This was just as risk-free Treasury rates were starting to rise. Interestingly, similar to as they did in 2022, they ended up peaking in October. That said, with the latest news from The Fed suggests that there could be three interest rate cuts next year, RLTY appears to be a strong candidate with a steep discount. The party appears to be just beginning as recovery takes hold in the real estate investment trust sector of the market.
The RLTY outperformed the market in terms of total return during this relatively short period, as rates began to weaken, allowing a recovery to begin to take hold. Since our last cover, the the discount had actually widened slightly over this period, meaning underlying performance would have been even better in the portfolio.
With the FOMC meeting and the release of the Fed’s new projections, yields fell after already falling significantly through November. We saw the market rebound, but, in particular, interest rate sensitive sectors, such as REITs, surged; the utility sector is also included in this category.
- Z score over 1 year: -0.78
- Discount: -13.52%
- Distribution yield: 9.38%
- Expense ratio: 1.81%
- Leverage: 35.59%
- Assets managed: $411.2 million
- Structure: Duration (liquidation date planned for February 23, 2034)
RLTY investment objective is “high current income”. The secondary objective is “capital appreciation”. To achieve this, the fund will invest “at least 80% of its managed assets in (i) real estate-related investments and (ii) preferred and other income-producing securities.” It’s quite simple and quite similar to Cohen & Steers’ other real estate funds.
The fund’s expense ratio is on the high end, and it’s actually up from the 1.74% operating expenses we saw at the end of its 2022 reporting. With leverage fees inclusive, the total expense ratio jumped to 4.98% from 3.14%. Of course, the main driving factor during this period has been the higher cost of leverage, which they employ rather high.
However, they offset some of these higher costs through interest rate swaps. Indeed, where they were taking a hit on the revenue side of the equation and seeing higher costs, they were offsetting the value of their swaps on the majority of their leverage.
Performance – Ready for recovery and attractively priced
Not only does RLTY’s portfolio include REIT investments that can benefit from a lower interest rate environment, but the fund also features a range of preferred securities. As rates fall, these investments become more attractive in terms of the returns they offer and can be increased by investors. This also adds a bit of a more conservative touch as the fund sits higher in the capital stack. This didn’t treat the fund well as it navigated a higher rate environment and the banking crisis in early 2023, but it could rebound. move forward.
On an annual basis, we can see quite clearly what has driven the prices and NAV results of RLTY throughout this year relative to the 10-year Treasury rate. In particular, over the last few months, the fund has been strongly influenced by the evolution of this risk-free rate.
Despite what is already a solid recovery from the lows, this fund remains, in my opinion, attractively priced. While not necessarily the oldest fund, it is the one with the largest discount to its sister funds, Cohen & Steers Quality Income Realty Fund (IQR) and Cohen & Steers REIT and Preferred Income Fund (RNP).
Of course, history can influence the valuation that investors are willing to assign to a position. Also, the other caveat is that RLTY is more of a “middle” sister in that RNP is about 50/50 between stock and preferred, and RQI is about 80/20 respectively. RLTY is about 67/33 between the two asset types.
An absolute basis is not always as informative; we often want to look at a fund’s relative discount to its historical levels. Since the RLTY is new, we don’t really have a big range to go back to yet. That’s why I think comparing it to its peers, in this case, makes a lot of sense in determining where a relative value would be appropriate for RLTY. The fund is also a term fund, but if successful it could easily become a perpetual fund if the board decides to pursue that path.
Speaking of the fund’s discount, this works in a CEF investor’s favor in that it also means they receive a higher distribution yield relative to what the fund stands to earn. Specifically, the fund’s NAV distribution rate stands at 8.11% while investors receive a rate of 9.38% based on buying at today’s price.
Additionally, they increased the rate they were paying earlier this year to $0.11 per month from $0.1040 per month.
Given the funds raised during the distribution, I suspect they are more than happy to leave the payment where it is. That said, we can always take a look at the latest numbers. In their last semi-annual report, NII coverage stood at approximately 17.7%.
On a per share basis, over a six month period, that equates to $0.11, which is exactly what they pay in a single month. However, as we noted above, interest rate swaps took hold and generated capital gains.
Like the vast majority of CEFs that invest heavily in stocks, they rely largely on capital gains to finance their payments. This is one of the main reasons why their payout rates are so high. On top of that, Cohen & Steers REIT funds tend to invest in relatively low-yielding investments and have more of a growth orientation.
Another common comment regarding RLTY is that it pays return of capital distributions while its older peers do not and instead displays capital gains distribution tax classifications. It is totally true.
They estimate that part of the 2023 distributions will be the same, including the return of capital. However, ultimately the main argument is that whether the tax classification is return of capital or capital gains, assets are still flowing out of the fund to compensate investors at a time when the entire industry is facing to pressure. Simply put, RQI and RNP have been around longer and have built-in capital gains to build on.
RLTY, being a newer fund launched at a time when the REIT sector was slammed by higher rates, simply didn’t have that advantage. Ultimately, the total net asset value returns of the leveraged C&S CEF trio were virtually the same.
This reminds us that tax classification is not a measure of performance but simply what it is, and that it is a tax classification that is important for taxes and not for whether a fund performs well. poor performance compared to another.
Looking at the fund’s portfolio, we notice some overlap with its older sister funds. This is to be expected and is why we see such similar performances despite differences in equity/preferred weightings. RLTY lists 173 stocks, but the top ten make up a significant overall fund allocation at 42%. These are all equity positions, as also shown in the breakdown, so relatively speaking, preferred positions constitute smaller positions.
The fund has not seen any drastic changes in major holdings since our last update. SBA communication (SBAC) made its way into the top ten, while Crown Castle (CCI) slipped outside the top ten titles. However, this remains a position; it just got a little smaller.
Interestingly, as I wrote this, American Tower Corp (AMT) has just announced a quite significant bump in their quarterly dividend. This is interesting but perhaps not surprising, as it is a common characteristic of these positions. AMT often increases every quarter, at least historically, although it missed a hike earlier this year. That’s why the 4.9% increase may not seem like much at first, but when they increase the most each quarter, those increases really start to add up.
AMT was one of those positions that took a deep beating during the October risk-free rate spike, but it rebounded significantly. Even with this latest rise to $6.80 annualized, we’re looking at a yield of around 3.1% at the latest closing price. Of course, as prices increase, the yield decreases, like a bond assuming the stock position keeps its payout stable. In this case, that meant AMT’s dividend yield was even lower than it was just a few months ago.
Even with the latest share price rise, it’s not like AMT is overpriced relative to its historical average. While the argument is that the historical average is less useful here due to the context of now higher rates, I think it nevertheless provides good context overall. Additionally, if rates are to fall next year, this historical valuation range will become even more relevant.
RLTY is poised for strong performance as the REIT sector continues its recovery. With the Fed recognizing that inflation is falling, rate cuts are now closer than initially expected. This can help propel the space higher, and with RLTY trading at a significant discount, it is an additional catalyst for upside. At the same time, the fund pays a healthy distribution to investors while awaiting potential capital appreciation.