RLTY - RNP: One Of The Best Real Estate Closed-End Funds

2023-12-29 10:11:36 ET

Summary

• The Cohen & Steers REIT & Preferred Income Fund is a well-diversified closed-end fund focused on real estate, with a strong track record of outperforming its benchmark.
• RNP's portfolio consists of high-quality REIT equity and preferred stock, with a focus on best-in-class real assets diversified globally.
• The fund offers a monthly dividend, making it an attractive option for investors seeking predictable income. However, the best opportunity for RNP may have passed as investors anticipate potential rate cuts in 2024.

The Cohen & Steers REIT & Preferred Income Fund ( RNP ) is one of the largest real estate focused closed-end funds, combining primarily REIT equity and preferred stock. The portfolio is high quality and well-diversified across sectors and geographies. The fund has performed well over decades, repeatedly outperforming its blended benchmark and the broader REIT indices.

RNP was tested as interest rates increased, putting significant valuation pressure on the fund's portfolio. Bear in mind, a portfolio of REITs and preferred stock is inevitably exposed to movements in interest rates. Despite the challenges, the fund has maintained its dividend and begun to rebound as investor optimism surrounds potential rate cuts in 2024.

There are three reasons why RNP is one of our favorite closed-end funds: the manager, the portfolio, and the monthly dividend. Each of these elements is best in class and deserves attention from investors selecting a closed-end fund. Let's dive in and discuss each piece, and our outlook, in greater detail.

The Manager

Cohen & Steers ( CNS ) is a New York-based asset management firm founded in the 1980s by Martin Cohen and Robert Steers. The company specializes in publicly traded real estate and infrastructure investments, building a reputation over decades through strong, consistent performance, and conservative management. The firm continues to grow and add additional offerings, staying close to their core competencies. In 2021, CNS even announced an expansion into private real estate, including deal sourcing and transaction advisory, making the group a well-rounded asset manager. Today, the firm manages over $75 billion in assets.

Source: Annual Report

The Portfolio

RNP's portfolio is a split of REIT equity and preferred stock, with miniscule allocations elsewhere. The fund also includes the limited use of derivatives, a luxury of closed-end funds, such as covered call and cash-secured put options. The graphic below from CNS illustrates the equal weight of the portfolio, in line with the fund's benchmark.

Source: CNS

Under the fund's hood are some of the largest names in real estate. The top five holdings are American Tower Corporation ( AMT ), Prologis ( PLD ), Welltower ( WELL ), Invitation Homes ( INVH ), and Simon Property Group ( SPG ). These five are the largest operators in their respective asset classes and represent 19.2% of RNP's portfolio. AMT is the world's largest REIT by market capitalization and manages cell towers across the globe. PLD develops, owns, and finances industrial real estate across the globe and owns a substantial portion of the world's logistics facilities. WELL is the largest owner, operator, and developer of senior housing properties. INVH owns a large, diverse portfolio of single-family rental properties. SPG owns, operates, and develops shopping centers across the United States. It's more than likely that most readers have shopped at a Simon mall.

The point being, RNP's portfolio is built from best-in-class real assets diversified across the globe. While every REIT provides its own layer of diversification, RNP benefits from the manager's active management, which further diversifies the portfolio and provides an opportunity to outperform through security selection. This security selection and the fund's use of leverage have powered RNP to trounce its index over time.

Source: Fact Sheet

Niche asset classes such as REITs offer a better opportunity to outperform the underlying index as compared to larger categories such as large-cap growth. Managers such as CNS have historically predicted the relative performance of real asset classes against a macroeconomic backdrop with a degree of accuracy. Financial analysis is also key in industries with close competitors, such as real estate. As illustrated above, the portfolio is dominated by large, blue-chip operators across major asset classes. The manager can remove struggling REITs in favor of strong performers. This relative outperformance adds up substantially when given the opportunity to compound. Over the past ten years, RNP has nearly doubled the return of its respective benchmark.

The Dividend

Undoubtedly, the most attractive piece of any closed-end fund is the yield. The structure of a closed-end fund requires a large annual distribution of income and capital gain to avoid penalties. As such, closed-end funds generally distribute large annual dividends to shareholders. RNP, like many closed-end funds, opts to send shareholders an equal monthly dividend, supplemented by an annual distribution as necessary.

For shareholders seeking predictable income, this structure closely replicates what we dream a real estate investment could be…mailbox money. Keep in mind that compared to a traditional real estate investment, there are also no management responsibilities or capital expense liabilities.

For over a decade, RNP has sustained or increased its monthly distribution, with the last reduction being the Great Recession. Additionally, the fund's yield has become more attractive as rising rates have pressured REIT and credit valuations.

However, the best has likely passed as investors look ahead to potential rate cuts in 2024. The infamous "REIT rebound" in the fourth quarter has priced in a significant amount of optimism for multiple rate cuts and a strong real estate recovery. Even still, RNP's current yield offers a meaningful spread over current treasury rates.

Outlook

As we mentioned, the best opportunity for RNP has likely passed. Before the Fed's pivot , investors priced in a sustained high interest rate environment. This outlook was negative for RNP due to the fund's leverage and underlying holding's interest rate exposure. However, the recent change in tune offers light at the end of a previously dark tunnel. While real estate remains under pressure, the economic outlook for RNP's portfolio is positive.

Current interest rates offer an opportunity for RNP to invest in REIT equity and preferreds at significantly higher yields than in the era of perpetually low interest rates. Additionally, inflation has propelled rent growth across asset classes and geographies, equating to substantial re-leasing spreads for landlords and operators. For example, STAG Industrial ( STAG ) recently signed a 646,200 square foot industrial lease at a 49.8% cash rent change. This is not an isolated example as other REITs demonstrate similar levels of growth in new leases. These strong leasing spreads mean increasing cash flow to the REIT and ultimately RNP's portfolio.

Source: NAREIT

Additionally, publicly traded REITs have borne the brunt of the cap rate carnage from the past two years. As illustrated above, the implied cap rates of public REITs have expanded dramatically over the past seven quarters, while appraisal and transaction cap rates have not moved substantially. Should the Fed cut rates, public REITs will be the fastest, most accessible vehicle to access real estate. Like how investors fled public REITs initially due to their liquidity, the market could repeat that trend on the upside as investors race to pivot.

Conclusion

This thesis has begun to unfold as RNP's share price has increased nearly 30% in the past three months. Despite the recovery, there remains room to run as the fundamentals of the portfolio remain strong and the outlook brightens. REIT valuations remain conservative, providing an opportunity for future growth into 2024. The best time to purchase RNP may have passed, however, the fund remains a best-in-class opportunity for investors to generate monthly income in their portfolio. As with most top performers, the best time to buy was yesterday, and the best time to sell is never. I remain long on RNP and will continue to accumulate shares.

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