Cohen & Steers Quality Income Realty Fund (NYSE:RQI) is selling on the cheap, trading hands at a discount of over 10% compared to the value of what it owns. And it owns some of the real estate investment trust (REIT) industry's biggest and best run companies. Add in a nearly 6.5% yield and you can't afford not to look at Cohen & Steers Quality Income Realty Fund if you are considering buying REITs.
Do it yourself or ready made?
When it comes to investing, you have two broad choices-do it yourself or pay someone else to do it for you. Doing it yourself can be incredibly rewarding financially and emotionally, but it takes a massive amount of time and effort. This is why so many people let someone else do the heavy lifting. If you're reading this, however, you're probably a do it yourself type person. But that doesn't mean you shouldn't consider hiring some experts.
One slightly obscure area of the "financial outsourcing" industry is closed-end funds. These securities allow investors to pool their money and hire a professional to create a portfolio. That's much like an open-end mutual fund. However, closed-end funds trade on exchanges like stocks based on supply and demand because there are a set number of shares issued. Open-end mutual funds, by comparison, stand ready to buy and sell shares every day at the value of their portfolios, called net asset value or NAV.
This is where it gets interesting. Since closed-end funds trade like stocks with a set number of shares, their price often diverges from the value of their portfolios, or NAV. That leads to what are called premiums and discounts. The latter is what you want to find because it allows you to buy, for example, $1 worth of stocks for $0.90-that's basically the opportunity right now in real estate with Cohen & Steers Quality Income Realty Fund.
Lest you think something fishy is going on, pick up a copy of The Intelligent Investor by famed value investor Benjamin Graham. Chapter nine, Investing in Investment Funds, details the opportunity offered by purchasing closed-end funds at a discount. But a big part of the value is actually allowing an expert to handle a portion of your portfolio so you can spend more time on other parts.
So you're not a REIT expert?
One of Graham's core suggestions is to focus on a small area of competence. For most investors he said sticking to buying large, financially stable companies when their prices are cheap is the best course of action. That's great advice, but only helps so much if you are trying to live off your dividends. But by owning a fund like Cohen & Steers Quality Income Realty Fund, you can get the income, get the discount, and outsource the investment process to a team of experts in an area in which you may not be an expert.
Hiring those experts isn't cheap, Cohen & Steers Quality Income Realty Fund, for example, charges around 2% of assets. So it's not exactly a win/win, but it's a great compromise if you just so happen to NOT be a REIT expert yourself but recognize the value REITs offer to income investors.
But paying for these outsourcing services means you need to understand what you're getting with Cohen & Steers. If you don't know the company, don't be upset, it's a niche shop founded in 1986 by Martin Cohen and Robert Steers (thus the name) to specialize in "listed real estate." They were, basically, the first Wall Street shop dedicated to REITs. The company manages over $50 billion in assets today. If you buy a Cohen & Steers product, you are hiring people steeped in the real estate business.
Knowing what you own
Quality Income Realty Fund, meanwhile, lives up to its name. It's top five holdings are Simon Property Group Inc. (NYSE:SPG), Equity Residential (NYSE:EQR), Prologis Inc. (NYSE:PLD), Ventas Inc. (NYSE:VTR), and Vornado Realty Trust (NYSE:VNO). These holdings, which are all high-quality industry leaders, make up roughly 20% of the portfolio, which contains around 120 names. Although every REIT Cohen & Steers has packed into this fund isn't of the same quality, the largest names (well beyond the top five) really are high quality companies.
That said, if you do a deeper dive into these REITs you'll notice that none offers a yield anywhere near 6.5%. And that's something you'll need to take into careful consideration. Closed-end funds can be great for income investors, but they don't just pass along dividends. For example, Cohen & Steers Quality Income Realty Fund's third quarter distribution consisted of roughly $0.05 of dividend income and $0.14 of capital gains. In other words, the sale of appreciated assets helped fund the distribution.
In fact, portfolio dividends alone historically haven't been enough to cover the fund's distributions, which are currently set at $0.19 a quarter. Capital gains and return of capital have been needed to do that. Some investors view this as a major drawback of closed-end funds, since owning a dividend paying company directly could mean never having to tap anything but dividends.
However, anyone with a portfolio of stocks knows that buying and selling is an ongoing part of life. And Cohen & Steers Quality Income Realty Fund's distribution policy allows you a steady stream of income over time without the need to think about the ups and downs within the portfolio. Such a set dividend is known as a managed distribution policy.
You'll just need to be careful that return of capital distributions (essentially giving you back your own money) don't occur over long periods of time and ultimately reduce the closed-end fund's NAV. Having this stability over short periods of time, perhaps a year or two, is great, but too long is not good either. (Note, that even if you only got return of capital, you'd be getting $1 for every $0.90 invested in Cohen & Steers Quality Income Realty Fund as the fund essentially liquidated itself because of the discount to NAV... not exactly a bad thing.)
Taking a look at recent history, over five years between 2009 and 2013, Cohen & Steers Quality Income Realty Fund's NAV fell in two years for a total of roughly $0.47 a share. In the other three years NAV increased over $5.62 a share, more than making up for the shortfall. It paid dividends throughout the span totaling $3.12 per share.
Cohen & Steers also uses leverage to enhance performance at this fund. This can lead to outperformance in good times, but underperformance in bad times. That said, Cohen & Steers Quality Income Realty Fund has outperformed the S&P 500 Index by nearly two percentage points a year through October 2014 since its founding in February of 2002, assuming the reinvestment of dividends. The performance is even better when looking at NAV instead of market price. It hasn't achieved this level of success in every trailing time period or in every year, but overall the closed-end fund has rewarded investors for their commitment.
And while you may not reinvest dividends, which will mean your results won't match the fund's reported stats, you will clearly be hiring portfolio managers that have handled themselves well-even through difficult periods like the 2007 to 2009 property-led recession.
Is it worth it?
If you are an income investor and realize you can't be a specialist in every dividend focused asset class, Cohen & Steers Quality Income Realty Fund could be a good option for you. That's particularly true since it's trading at 10% below its NAV. You'll get a steady dividend payment providing a meaty, though not over the top, 6.5% yield. You'll also get industry experts and a portfolio full of industry-leading companies. This all comes at a cost, but in the end that cost may be well worth it if you can sleep well at night and focus more on the things you're good at.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.