- Every investor should have some exposure to real estate as a way to protect themselves against inflation, which could be a real problem in the near future.
- RNP is a very solid fund that splits its investments between real estate and preferreds in order to generate income.
- The fund is quite well-diversified throughout both portions of its portfolio, which is appealing.
- RNP was able to maintain its distribution straight through the worst of 2020 and was even able to fully cover it with dividends and capital gains.
- The fund is surprisingly trading at a slight discount so the price looks right.
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Over the past few weeks, I have discussed how real estate and real estate investment trusts can protect your wealth against the ravages of inflation. Inflation is a problem that greatly affects retirees since it increases the chances that you will outlive your money unless you reduce your quality of life every year. Who wants to do that? It can sometimes be difficult to pick and choose among the various real estate opportunities on the market, however; so one alternative is to invest in a real estate-focused closed-end fund. These funds have a few advantages over open-end or exchange-traded funds including the fact that they enjoy professional management and typically boast higher yields than most other things on the market. This second point is likely to be very appealing in today’s low interest rate world. In this article, we will look at one of the better real estate funds in the space, the Cohen & Steers REIT & Preferred Income Fund (NYSE:RNP), which currently yields 5.28%. I have discussed this fund before but it has been over a year so in some ways this will serve as an update but it will also include an analysis of how well the fund has weathered through one of the most challenging economic environments that many of us have ever seen.
About The Fund
According to the fund’s web page, the Cohen & Steers REIT & Preferred Income Fund has the objective of providing its investors with a high level of current income. This is certainly not surprising as that is the objective of just about every closed-end fund that focuses on investing in the fixed-income space. Admittedly, this one is not purely a fixed-income fund as it invests in both preferred stock (which is a fixed-income product) and real estate investment trusts (which are not). Real estate trusts tend to deliver a significant proportion of their returns in the form of distributions though so that makes them similar to fixed-income products in a way. The fund does not explicitly state any sort of restriction as to what percentage of its assets must be invested into each of the two security types, so presumably management can be flexible on this. That could be a positive thing as it allows greater freedom to adjust the portfolio based on the prevailing market conditions.
The Cohen & Steers REIT & Preferred Income Fund is currently almost evenly split between fixed-income and real estate investment trusts. The fund has 47% of its assets invested in preferred securities, 2% in cash, and 51% in real estate trusts. This gives it a fairly respectable balance between income generation and capital gains potential. Preferred stocks, as a fixed-income product, normally have higher yields than the common equities of real estate trusts. However, their prices are mostly dependent on the movement of interest rates and not on the performance of the underlying company or the value of its real estate portfolio. Thus, the preferred stock will not have the same potential for capital gains. The fact that the value of the underlying trust’s real estate portfolio has an impact on the valuation of the trust’s common equity also allows these securities to provide a hedge against inflation, which the preferred stock cannot do. This could prove to be quite important going forward as we will see later in this article.
The largest real estate positions in the fund will likely be familiar to anyone that follows that particular sector of the market. Here they are:
Source: Cohen & Steers
A few of these holdings are similar to the last time that I reviewed the fund, although the weightings have been reduced. In particular, American Tower Corporation (AMT) is still the largest position in the fund. American Tower is certainly not what most people think of when they picture a real estate company as it does not own office buildings that people live in or shopping malls where they shop. The company instead owns cellular phone towers located throughout the United States and the world. The company leases out these towers to telecommunications companies that are looking to expand their networks. Along with its peer Crown Castle International (CCI), the company saw very good stock performance over the past few years due to general excitement over fifth-generation cellular technologies. As 5G requires that cellular towers be placed much closer together, the general expectation was that this would represent fairly significant growth potential for these companies. The fund’s management may believe that this drove the stock to overvalued levels as the weighting of this company in the fund is lower than it was when I last reviewed it. Interestingly though, the weighting to Crown Castle International has remained roughly the same.
One interesting addition to the fund’s largest positions list is Simon Property Group (SPG). Simon Property Group is the largest owner of shopping malls in the United States and some would argue that its malls are the highest quality ones. The pandemic was devastating to this sector of the real estate market. Shopping malls tend to attract crowds and the forced quarantines and a general fear of being in crowded places has generally resulted in shopping malls seeing far less traffic than they are used to. Many tenants of these properties have since gone out of business, which naturally reduces the rent that is collected by mall owners like Simon Property Group. The addition of this company to the fund appears to be a contrarian bet by the fund’s management that the sector will rebound and people will soon get back to their pre-pandemic lives and revitalize the shopping mall sector. I have my doubts about this even though there are now vaccines available for COVID-19. First of all, there have been serious problems getting the vaccines distributed and it will almost certainly take longer to get everyone vaccinated than what some optimists are projecting. In addition, there has been a resurgence of COVID-19 cases in states such as Michigan despite the presence of the vaccine and this may cause many people to continue to self-isolate and avoid crowded places such as shopping malls. Dr. Fauci himself states that he continues to avoid such places even though he has been vaccinated. Finally, there is the fact that the financial damage has been too severe for many tenants of shopping malls and they will be unable to reopen even if mall traffic does return. Thus, I am not too sure about management’s contrarian investment here even if Simon Property Group is the best operator in the sector.
As my regular readers on the topic of closed-end funds are likely aware, I generally do not like to see any single asset in a fund account for more than 5% of the fund’s portfolio. That is because this is approximately the level at which that asset begins to expose the fund to idiosyncratic risk. Idiosyncratic, or company-specific, risk is that risk which any asset possesses that is independent of the market as a whole. This is the risk that we aim to eliminate through diversification but if the asset accounts for too much of the portfolio, then it will not be completely diversified away. Thus, the concern is that some event may occur that causes the price of that particular asset to decline when the overall market does not. If that asset accounts for too much of the portfolio, then it could end up dragging the entire fund down with it. As we can see above though, the Cohen & Steers REIT & Preferred Income Fund is quite well diversified with no single position accounting for more than 5% of the fund. This is actually an improvement over the last time that I reviewed the fund. Thus, there does not seem to be anything to worry about here.
The fixed-income portion of the portfolio, comprised of preferred stocks, is also reasonably well diversified as shown here:
Source: Cohen & Steers
There may be some readers that point out that the fund’s preferred portfolio is very heavily weighted towards the financial sector. This may be concerning to some but the fact is that pretty much every preferred portfolio will be heavily weighted towards financials. This is because the financial sector is the largest issuer of preferred stock in the market. That is mostly due to international banking regulations that require a bank to have a certain percentage of its assets in the form of Tier one capital. Tier one capital consists of the money that a bank raises through the issuance of common or preferred stock so using preferreds offers the banks a way to meet regulatory rules without needing to dilute the common stockholders. The S&P U.S. Preferred Stock Index is comprised of 65.4% financial sector securities, although the index appears to lump banks and insurance companies together. We can see though that overall this fund is not too far off the index.
Real Estate For Inflation Protection
Earlier in this article, I stated that real estate could be one way to protect yourself against inflation. This is something that may become increasingly important over the next few years because of a few actions that were undertaken by the United States government, the Federal Reserve, and various other governments and central banks around the world in order to combat the economic damage that was inflicted by the COVID-19 pandemic. Economists define inflation as a broad-based increase in prices throughout an economy and it is generally considered to be a natural phenomenon. However, what actually causes it is the money supply growing faster than the production of goods and services in the economy. This is because that scenario basically means that more money is available to purchase each unit of production. This was certainly the case in the United States over the past year. We can clearly see this by looking at the M3 money supply, which is the most comprehensive measure of the supply of money in an economy.
As of January 2021 (the most recent date for which data is available as of the time of writing), the M3 for the United States sat at $19.3946 trillion. This represents a 25.80% increase over the $15.4164 trillion that existed back in January 2020:
Source: Federal Reserve Bank of St. Louis
The biggest reason for this increase was the various measures that the fiscal and monetary authorities undertook in the face of the pandemic. In March 2020, the U.S. Congress passed the CARES Act, which was at the time the largest individual spending bill in American history. As I discussed in a previous article, this $2.2 trillion spending bill was entirely financed by the Federal Reserve essentially printing new money. The Federal Reserve itself also started buying up corporate bond ETFs for the first time ever, which was also done with newly printed money. We can likely assume that the money supply is even larger today. This is because the above data came before either the $900 billion stimulus package or the $1.9 billion package that has since been passed had a chance to be completely financed. We can assume that both of these stimulus spending programs will be funded the same way, further swelling the money supply.
It should be fairly obvious that the production of goods and services in the economy did not increase by anywhere close to this amount over the past year. As of the fourth quarter 2020, America’s gross domestic product sat at $21.494731 trillion, which is a slight decrease over the $21.747394 trillion that it boasted in the fourth quarter of 2019:
Source: Federal Reserve Bank of St. Louis
This is overall a recipe for inflation, especially if some of the government officials crying for more spending end up getting their way. One way to preserve your purchasing power in such an environment is to own real estate. This is because real estate prices should climb in an inflationary environment due to the fact that it is in limited supply and takes real effort to develop and improve. The Cohen & Steers REIT & Preferred Income Fund is one way to gain this exposure.
As noted earlier, the primary objective of the Cohen & Steers REIT & Preferred Income Fund is to provide a high level of current income to its investors. As such, we might expect the fund to pay out a regular distribution to its investors. This is indeed the case as the fund currently pays out a distribution of $0.1240 per share monthly ($1.488 per share annually), which gives it a 6.00% yield at the current price. This is admittedly not the highest yield in the closed-end fund space but some investors may still find it attractive due to the consistency that it has exhibited over time:
Source: CEF Connect
Another thing that investors may find appealing is that these distributions are entirely classified as capital gains or dividend income with entirely no return of capital component:
Source: Fidelity Investments
The reason why this may be appealing is that a return of capital distribution can be a sign that the fund is returning the investors’ own money back to them. This would obviously not be sustainable over any sort of long-term basis. Obviously though, we do not need to worry about that here since both dividends and capital gains imply that the fund is producing enough income off of its portfolio to cover the distribution. It does seem a bit hard to believe that the fund was able to so consistently generate capital gains in 2020 given the overall problems in the economy though so let us investigate this further.
Fortunately, we have a very recent report that details the fund’s performance for the full-year period ended December 31, 2020. Thus, this report should show us how the fund weathered through the market collapse and most of the subsequent recovery. Over the course of the year, the fund collected $34,231,419 in dividends and another $25,118,569 in interest from the investments in its portfolio. The fund also reported a bit of income from other sources bringing its total income to $59,429,992. The fund then paid its expenses out of this, leaving it with $37,566,765 available for distribution to the shareholders. This alone was not enough to cover the $70,802,304 that the fund actually paid out. However, we already saw that the fund was classifying some of the distributions that it paid out as capital gains. The Cohen & Steers REIT & Preferred Income Fund did actually realize $38,816,211 in net gains. When we combine this with the fund’s net investment income, it did generate enough money to cover the distributions in full. It is worth noting though that the fund did have some unrealized losses that would offset the gains and overall it did see the total value of its portfolio go down during the year. However, these are only unrealized losses so it is quite possible that the fund will be able to recover from these losses if the stocks rebound. This is not an unrealistic scenario given the overall bullish case for real estate in the face of inflation.
As is always the case, it is critical that we do not overpay for any asset in our portfolios. This includes very solid performing real estate-focused closed-end funds. The reason for this is that overpaying for any asset is a sure-fire way to ensure that we generate a suboptimal return off of that asset. In the case of a closed-end fund like the Cohen & Steers REIT & Preferred Income Fund, the usual way to value it is by looking at a metric called the net asset value. The net asset value of a fund is the total current market value of all of the fund’s assets minus any outstanding debt. It is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.
Ideally, we want to purchase shares of a fund when we can obtain them for a price that is less than net asset value. That is because such a scenario implies that we are acquiring the fund’s assets for less than they are actually worth. Fortunately, that is the case here. As of April 8, 2021 (the most recent date for which data is available as of the time of writing), the Cohen & Steers REIT & Preferred Income Fund had a net asset value of $25.15 per share but only trades hands for $24.82 per share. This gives it a discount of 1.33%. This is actually a more attractive price than the 0.97% discount that the fund had on average over the past month. I must admit that this is somewhat surprising too since Cohen & Steers funds usually trade at a premium as has been the case with all of their other funds that I have discussed over the past few weeks. Thus, the price certainly looks good here. Overall, this fund might be well worth considering for your portfolio.
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This article was written by
Power Hedge has been covering both traditional and renewable energy since 2010. He targets primarily international companies of all sizes that hold a competitive advantage and pay dividends with strong yields.He is the leader of the investing group Energy Profits in Dividends where he focuses on generating income through energy stocks and CEFs while managing risk through options. He also provides micro and macro-analysis of both domestic and international energy companie. Learn more.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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