RLTY - RLTY: This REIT Fund Is Only For Those Who Have Faith In The Sector

2023-11-13 18:24:08 ET

Summary

• Cohen & Steers Real Estate Opportunities and Income Fund focuses on REITs and is a young fund with potential for investors comfortable with leverage.
• REITs have been in a bear market since late 2021, with prices down about -35% on average.
• RLTY currently trades at a NAV discount of -13.4% and holds REITs with a history of solid dividend growth.
• If you are a believer of REITs in general, you might want to buy this fund.

Cohen & Steers Real Estate Opportunities and Income Fund ( RLTY ) is a CEF that focuses on REITs. This young fund which has been around for less than 2 years can provide an opportunity for investors who are comfortable with some leverage.

The fund was somewhat unlucky because it couldn't have launched on a worse day. The fund launched last year on February 24th which was the start date of the Russia-Ukraine war which didn't exactly trigger the bear market we had last year by itself but definitely played a role in accelerating it by boosting inflation (in terms of commodity and energy prices) which probably caused the Fed to become more aggressive than it would have been otherwise.

REITs in general have been in a bear market since late 2021 and we might not have seen the exact bottom in REITs even though the overall stock market bottomed in October 2022 and had a strong rally since then. REIT prices are now down about -35% on average and this is also in line with long-term bond prices which have also been in a bear market during the same period.

Since RLTY invests into REITs, the fund has been down significantly since its inception even with dividends reinvested but there are no surprises there. When a segment of the market is in a bear market, any funds that focus on that particular segment will also be in a bear market. I am actually surprised that it's not down even more than this considering this fund is about 35% leveraged which I will talk about more later on. Having said that, it is also generally said that the best time to buy an asset is when it's in a bear market because things tend to be on a discount and this fund's buy-zone might be approaching soon.

The fund currently trades at an NAV discount of -13.4%. Since the fund hasn't been around for that long, it's hard to establish a long-term average for the fund's NAV discount/premium status but this number is close to the bottom of its nearly 2-year average with the exception of a brief period in July 2022 when the fund's NAV discount was close to 18% for a very short time. We need more time to establish what appropriate NAV discount for this fund but a range of 13-15% discount provides at least some level of safety for investors who want to gain exposure to this fund.

When I looked at the fund's top 10 holdings, I couldn't help but notice one thing. Almost every single one of them is known for having a history of solid dividend growth. For example, the fund's top holding American Tower Corporation ( AMT ) has a 10-year annual average dividend growth rate of 19%. The fund's second-biggest holding Prologis, Inc. ( PLD ) enjoyed an annual dividend growth rate of 12% for the last decade. Digital Realty Trust, Inc. ( DLR ) is another major holding of this fund and its dividends have been growing for 18 years straight. Realty Income Corporation ( O ) has a dividend growth history of 25 years and so on.

In general, REITs are famous for having high yields but not all REITs post dividend growth. As a matter of fact, the most known REIT index ETF, Vanguard Real Estate Index Fund ETF Shares ( VNQ ), posted virtually no dividend growth in the last decade so I like that RLTY holds a large number of REITs that have a strong history and focus of growing their dividends. This also means that we could expect to see some dividend hikes from this fund in the long term. Keep in mind that not all of the fund's holdings have a history of dividend growth but enough of them do. The fund also holds a large number of preferred stocks which tend to have higher yields but no dividend growth. In fact, preferred stocks account for about 30% of the fund's total weight.

RLTY has a current dividend distribution yield of 10.3%. We know that most of the fund's holdings yield about 5% and it trades at a 14% discount against its NAV so that accounts for a real yield of 5.7%. We also know that the fund has a leverage of about one-third, so that takes the "real yield" to 7.7%. The rest of the yield (about 2.6%) will come from either capital gains or return of capital mostly depending on whether the fund's stock holdings appreciate or not during a given year.

Let's talk about leverage. As with most CEFs, this one also employs some leverage to boost its returns. Currently, the fund's leverage ratio is 37.9%. This also explains why the fund has such a high expense ratio of 1.59% because a big chunk of its expense ratio goes to cover its interest expenses for the leverage it uses. Leverage is a double-edged sword which can work for you or against you depending on whether you are on the right side of the market or not. During a bear market, a leverage of 40% can increase your losses by 40% and during a bull market the same leverage can boost your returns by 40%. In order to invest in this CEF (as with most CEFs) you must be comfortable with its usage of leverage. I tend to think that since REITs have been in a bear market for 2 years and average REITs already dropped by about 35%, we must be closer to the bottom than the top so I am not too bothered by this amount of leverage personally but your opinion on the matter might differ. There are also a lot of people who think that we are on the brink of a recession which would mean that stocks and REITs might drop significantly from here which would make the leverage work against you if those people are correct. I should also note that 86% of the fund's leverage has fixed-rate interest with average rate being 2.9% so the fund is getting a relatively good deal on its leverage usage considering the average margin rate today is above 8% for most retail investors.

At the end of the day, this comes down to one thing. If you are bullish on REITs in general and think that REITs now present a good value after 2 years of selling off, this fund presents a good opportunity to take advantage of the situation. I am personally in that camp for the most part. If you believe that REITs have a lot more to fall and their pain is only beginning, then you may want to wait for a better entry point for the fund which may or may not come to you. I own a small position in this fund and plan on adding more (as well as reinvesting dividends along the way).

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