2023-04-18 06:22:04 ET
Summary
- The cost of leverage for the Cohen & Steers Quality Income Realty Fund has risen as rates have gone up, this fund now has a high expense ratio of 2.21%.
- Rising rates are hurting this fund in multiple ways, and many REITs are also facing structural challenges as much of the workforce remains remote.
- This Closed Ended Fund lacks diversity, the top 10 holdings make up 49% of the fund, and the top 4 holdings make up 25% of the fund.
Few investments have been more popular for individuals seeking income and dividends over the last decade than Real Estate Investment Trusts. With rates remaining low for an extended period of time and markets volatile, these investments offered many individuals income without excessive risks.
One of the more well-known closed ended funds that focuses on real estate is the Cohen & Steers Quality Income Realty Fund ( RQI ). This fund was started in February of 2002, and this CEF has done reasonably well over the last 2 decades.
This is an income-based fund, so even though the capital gains of this CEF have been limited, the total returns of this investment have been solid. This fund has offered investors nearly 485% in total returns over the last 21 years. Still, even including total returns, this closed-ended fund has also consistently and significantly underperformed the S&P 500 ( SPY ) and other benchmarks during this time period. The S&P 500 is up over 1,572% over the same time period.
Today, the Cohen & Steers Quality Income Realty Fund is a sell. This leveraged CEF is being hurting in multiple ways by rising rates, the expense ratio now exceeds 2%, and the REIT industry also faces structural challenges as well as more of the workforce becomes remote and the retail continues to move online. This CEF also lacks significant diversity, the top 10 holdings make up 49% of the overall fund.
The Cohen & Steers Quality Income Realty Fund is invested 100% in real estate, 17.21% in corporate bonds, 2.41% in government bonds, and .5% in cash and equivalents. This fund uses leverage, which is why the funds invested exceed 100% of stated capital. The current leverage ratio is 29%. The yield is 8.42%, the current funds under management are $1.62 billion, and the expense ratio is 2.21%. The expense ratio without leverage is 1.33%. This fund pays monthly distributions.
Rising rates have hurt this fund in several main ways. First, the cost of the leverage this fund uses has gone up, which is a significant part of the reason this closed-ended fund has a high overall expense ratio of 2.21%. The median expense ratio for a similarly managed CEF is slightly below 2%. This fund finances leverage through a fixed rate line of liquidity, and a variable rate. The Fixed rate makes up 81% of the cost of the fund's financing, and 19% of the financing costs are at a variable rate. The fixed rate payer is .95%, and the variable rate receiver is 4.34%, these rates move up as interest rates rise. The Cohen & Steers Quality Income Realty Fund has a 5-year dividend growth rate of just 4.5%, and the fund's top 4 holdings are all yielding 3.3% or less, this CEF is relying heavily on leverage to make the monthly payouts.
REITs usually depend heavily on the ability to borrow to finance residential and commercial mortgages, and tenants also often depend on lending markets to finance their leases or purchased properties. The main appeal of REITs is also income, and as rates rise the spread between the distributions these funds offer and the rate of the payouts fixed income instruments such as the 10-year treasury pay narrows. This lowers the price investors are willing to pay for these fund's assets. REITs have performed well when rates have been rising in the past, such as in 2014 and 2017, but that was when overall US economy was stronger since inflation was much less of an issue. Those time periods were also pre Covid when the commercial real estate market wasn't facing the same challenges this market is facing today.
REITs also continue face number of longer-term structural challenges as well shorter-term concerns today as well. Vacancy rates in San Francisco recently reached an all-time high of nearly 30%, and the overall vacancy rate for offices nationwide rose to a record 18.2%. Even though the industrial real estate market remains reasonably strong , there also continue to be signs that the US economy is weakening. Several leading companies, including Disney and Facebook, have recently laid off significant numbers of employees. Some key economic indicators, such as the recent durable good numbers, have also been concerning. Inflation rates continue to be high as well, and the Fed has made clear their goal for the rate of price increases remains at 2%.
A chart showing the rate of inflation (US Bureau of Labor Statistics)
This is why the Cohen & Steers Quality Income Realty Fund lack of diversity is concerning. The top 10 holdings make up 49% of this fund's total assets, and this CEF's top 4 holdings make up 25% of the fund's assets. This closed-ended fund's top 4 holdings are Prologis INC ( PLD ), American Tower Corporation ( AMT ), Welltower Inc. ( WELL ), and Realty Income Corporation ( O ). This fund does invest in variety of different types of real properties, but this CEF has concentrated most of their capital in several REITs that invest in specific types of real estate.
REITs performed well over the last several decades, but the economic and investing environment has changed significantly today. With rates likely to continue to rise, more people working remotely than ever before, and retail spending increasingly moving online, commercial real estate faces a number of new challenges. While REITs have worked for investor seeking dividends in the past, individuals whose primary goal is income should be able to finder stronger types of investments moving forward.
For further details see:
RQI: Rising Rates And Lack Of Diversity Make This Fund A Sell