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Real estate-focused closed-end funds have become a hot topic among real estate investors. From various points of view, these investments have become the subject of discussion and speculation by wise investors who want to invest their capital efficiently. First of all, these funds are actively Managed REIT funds are typically expensive and have higher expense ratios and leverage charges than mainstream REIT funds, which is why some investors choose to avoid management fees altogether by investing directly in REITs and accepting the burden of stock selection.
Either way, the main value proposition of real estate closed-end funds is the ability to provide a steady monthly income with higher yields than other comparable investment vehicles. Today, following our research, we revisit the best-performing REIT closed-end funds. coverage last year.
Cohen & Steers REIT & Preferred Income Fund (New York Stock Exchange:RNPP) is one of the world’s largest real estate companies. It is one of the top closed-end funds by assets under management. The fund combines REIT common and preferred stocks. Recently, the manager has started incorporating more derivatives into the leveraged portfolio, such as cash-secured put options on high-quality REITs. RNP’s portfolio is diversified across a variety of REITs by sector and region. The fund has performed well over the long term and has been a key player in the real estate (Vietnam) over the past 10 years.
The fund is managed by Cohen & Steers.central nervous systemCNS is a New York-based asset management firm specializing in public real estate and infrastructure investments. CNS is known for its growing platform of mutual funds, closed-end funds and separately managed accounts. Recently, CNS announced its expansion into private real estate with a new asset management platform.
The RNP was tested as interest rates rose, putting significant valuation pressure on the fund’s portfolio. Keep in mind that REIT and preferred stock portfolios are inevitably exposed to fluctuations in interest rates. Despite the challenges, the fund maintained its dividend and has begun to recover on investor optimism about a possible interest rate cut in 2024.
RNP’s real estate portfolio is a split of REIT equity and some additional smaller derivatives and private real estate investments. The derivatives section includes Equinix (Equix) and covered call options to generate additional yield.
RNP Fact Card
The fund includes some of the largest publicly traded REIT holdings. The top five holdings in RNP’s portfolio are American Tower Corporation (ATMT) 5.9%, Prologis (PLD) 4.2%, Welltower (good) 4.0%, Simon Property Group (Spain) 3.3%, Digital Realty Trust (DLR) is 3.0%. These landlords operate in unique sectors such as communications, industrial, and senior housing. They are all blue chip companies with huge enterprise value and are some of the largest landlords in the world.
RNP’s preferred allocation is more diversified and invests in more than just publicly traded REITs. The preferred allocation is invested broadly in financial, utility, insurance and a variety of other preferred stocks, creating a portfolio that is diversified beyond the real estate sector. Investing outside of real estate allows RNP to add diversification and other sources of yield, making it a better investment choice than Cohen & Steers Quality Income Realty Fund (RQI). RNP employs a multi-cylinder approach and has performed well over a range of time periods, including during periods of rising interest rates.
Assuming dividends are reinvested, RNP has outperformed the index over one-, three-, five- and 10-year periods. Clearly, the active management approach has worked to consistently outperform the fund’s benchmark. In fact, RNP is one of the few funds in the real estate sector to achieve such performance.
RNP Fact Card
Certain asset classes, including REITs, have a better chance of outperforming the market. The availability of information, market research, and other key factors allows specialized firms like CNS to utilize their expertise in a productive way. Although talented managers are few and far between, the CNS lineup has consistently outperformed in the real estate sector.
dividend
Most investors invest in closed-end funds with the goal of generating a portfolio yield. Closed-end funds are generally not tax efficient and distribute income and profits to investors annually. However, the steady income can be valuable to certain groups, such as retirees.
For investors looking for predictable income, the equal distribution policy adheres to the most important principle of perfect real estate investing: RNP pays shareholders a fixed monthly distribution, similar to how real estate investors would imagine a rent check. To sweeten the deal, RNP removes a layer of investor involvement and has no management liability.
RNP has maintained monthly distributions for over a decade, with the last reduction occurring after the Great Financial Crisis. Note that the 2016 distribution reduction was due to a switch from a quarterly to a monthly dividend. Since then, the fund has increased its monthly distributions in response to the strong performance of the REIT sector.
Based on the current share price, RNP’s monthly dividend equates to a yield of approximately 8%. Again, RNP’s dividends are derived from a combination of income, capital gains, and return of capital from the assets in the portfolio. Therefore, income accrues independently of the performance of the underlying assets. This means that during periods when the real estate market is doing well, the fund’s net asset value (NAV) will rise. On the other hand, if the fund earns less than its dividends, it will have to eat into its NAV to maintain its dividend payments. This creates an additional risk factor with RNP’s dividend compared to a typical REIT dividend.
Additionally, RNP’s dividends will not grow, which some shareholders may find unattractive. Without an appreciating income stream, RNP’s dividends will decline relative to the rate of inflation. Lack of growth is the trade-off for a high yield.
evaluation
There are various valuation methods for measuring the relative value of closed-end funds and similar investments. One example of a barometer of income-producing assets is the current yield on the 10-year Treasury bond compared to historical trends. It is called the risk-free rate because investors typically view the 10-year Treasury bond as a proxy for market risk. The second way to value a closed-end fund is its share price relative to its net asset value. Because shares trade independently, the market can push shares higher or lower than book value, making the fund’s current pricing more or less attractive.
Methodology 1: 10-year spreads
RNP yields have historically tracked the movement of 10-year Treasury yields. When systematic risk factors drive yields higher, RNP stock prices fall to compensate for the opportunity cost. In essence, RNP yields carry a risk premium above the risk-free rate of return.
Comparing the historical yield on the 10-year Treasury note to the dividend yield on the RNP gives us a comparison point for constructing an appropriate spread. Over the past 10 years, the RNP yield averaged 5.32% over the 10-year Treasury note at year-end. The minimum spread was 3.23% in 2022 and the maximum spread was 6.55% in 2020. Assuming a fair spread for the RNP over the 10-year Treasury note yield of 5.32%, we can construct a fair value matrix.
Data from REITer’s Digest and Seeking Alpha
Currently, the 10-year Treasury yield is just below 4.25%. Adding the historical spread of 5.32% to the current 10-year Treasury yield gives a fair yield on RNP’s dividend of 9.57%. Based on this dividend yield and RNP’s current monthly dividend of $0.136 per share, the estimated fair value of RNP is $17.06 per share.
This methodology suggests that RNP stock may be overvalued by up to 17% relative to historical yields. This implication stems primarily from the enthusiasm surrounding the possibility of interest rate cuts in the coming years, which will boost the REIT’s performance. Investors are looking to lock in higher yields in anticipation of lower Treasury yields. The optimism that is driving RNP’s outperformance of the index is leading to another valuation factor that is outperforming historical precedent.
Methodology 2: Discount/Premium to NAV
A common discussion point for closed-end funds like RNP is their share price relative to their net asset value. The ability to trade independent of NAV is a major advantage for funds like RNP, providing an attractive opportunity to add new capital or liquidate overvalued shares. Over time, premiums and discounts can fluctuate significantly, significantly impacting investor returns.
Historically, RNP shares have traded below their net asset value, meaning investors have the opportunity to purchase the asset portfolio below its liquidation value. Part of the price discount has been driven by skepticism and a certain amount of pessimism about the outlook for commercial real estate. Specifically, the Federal Reserve has Lowering interest ratesAs investor prospects begin to improve, RNP’s price will tighten. Over the past few months, RNP’s share price has risen and is currently trading slightly above its net asset value.
Some investors have no problem buying shares at a price above their net asset value. The idea behind it is that the whole of RNP or a similar fund is greater than the sum of its individual parts. In other words, RNP’s yield offers a greater opportunity in the eyes of a prospective buyer than the individual parts. Other investors may consider the shares to be too expensive in this scenario.
It is important to compare the current price to net asset value with historical trends. In the case of RNP, the fund rarely trades at a price above its net asset value.
Shares are currently trading at a slight premium, which is a leading indicator that RNP stock is getting caught up in the REIT rally frenzy: As hopes and expectations around interest rate cuts begin to build, investors have been buying RNP shares above book value, pushing yields lower in the process.
Conclusion
As investors patiently wait for the Federal Reserve to monitor inflation data and decide on the next steps in monetary policy, real estate is trending higher as enthusiasm over interest rate cuts starts to build again. For funds like RNP, this means investor enthusiasm has somewhat taken hold, pushing stock prices above their net asset value and historical yield spread over the 10-year Treasury note.
RNP is an excellent closed-end fund managed by one of the best asset managers in the real estate sector. However, after considering two valuation methodologies, we find RNP to be expensive compared to historical precedents. Investor expectations will drive performance, so caution is advised. Therefore, we maintain our rating of “Hold” on RNP.
