Cohen&Steers Total Return Realty Fund: a solid distribution
The Cohen & Steers Total Return Realty Fund (RFI) is a high performing closed-end fund focused on quality REITs. The fund has performed well over the past twelve months thanks to strong sector performance and management outperformance. Cohen & Steers (CNS) is one of the few asset managers to focus on REITs and the investment has paid off. RFI provided a stable and reliable distribution without the risk of additional leverage at the fund level. Even better, the current shareholders benefited from an exceptional management dividend at the end of 2021.
The fund is trading at an unusually high valuation. Historically, stocks have traded around their book value, sometimes at a noteworthy discount. However, the rebound from the pandemic and inflationary tailwinds fueled strong NAV performance and shareholder enthusiasm exceeded again. Today, RFI is approaching the highest premium of the last twelve months. That said, the fund deserves to be kept on your radar as a top performer.
Let’s dive into the fund and see where it stands.
Portfolio, performance and dividend
Real estate offers returns through rent collection and asset appreciation. In addition to the income paid monthly by tenants, real estate appreciates with inflation and market action, creating a powerful combination in a low-yielding inflationary environment like today. Real estate investment trusts offer investors a scalable way to access institutional real estate, bypassing significant barriers to entry. REITs often employ in-house legal, asset management and accounting teams, creating a streamlined investment that requires no intervention from the individual shareholder. This contrasts with the responsibilities of most rental property owners.
RFI’s portfolio is made up of high-quality REITs diversified across all sectors and geographies. The fund is built with a striking similarity to RQI, its leveraged sibling. In fact, both have significant overlaps in their top ten holdings with changes in weighting.
Sector diversification is similar with infrastructure (14%), healthcare (11%) and industrials (9%) leading the largest sector allocations. Investors should note that these tailwinds perform very well. Over the past twelve months, the industry has been the best performer, with market cap rates remaining within the 3.00% range. Above all, these investments are probably inaccessible to the majority of investors due to the high prices. SCPIs such as those making up RFI’s portfolio hold these high-quality assets.
Additionally, REITs inherently benefit from diversification, as each stock represents ownership of hundreds or thousands of properties. Going further, the fund benefits from an additional layer of diversification as management has built a portfolio of over 100 different REITs. RFI shareholders have indirect interests in tens of thousands of properties.
RFI performed well over all periods. The primary objective of the fund is current income supported by capital appreciation. Impressively, the fund has kept pace with the S&P 500, even outperforming in some periods. The strong performance is a pleasant surprise given the fund’s conservative approach and lack of leverage. RFI was able to compete with its leveraged siblings, the Cohen & Steers REIT & Preferred & Income Fund (RNP) and the Cohen & Steers Quality Income Realty Fund (RQI). This is becoming increasingly relevant as we approach a rising rate environment that will inevitably put pressure on RQI’s debt costs.
A significant portion of this return is achieved through the fund’s monthly distributions. Structured as a closed-end fund, RFI distributes regular monthly dividends from internal dividends and realized capital gains. RFI distributes a monthly dividend of $0.08 per share which is occasionally enhanced by a special annual dividend.
The realized capital gains determine the annual dividend. The result was a consistent, tax-efficient income producer that outperformed in terms of total return. For taxable accounts, the majority of the RFI distribution is comprised of capital gains adding another layer of efficiency.
Revenue producer, RFI offers an attractive distribution for three reasons. First, the distribution has remained stable for several years despite the fund’s high performance, even benefiting from several increases since the Great Financial Crisis. Second, the fund is composed primarily of capital gains and returns of capital, both of which receive favorable tax treatment. Third, the CEF structure of the fund provides special dividends during strong years. Real estate is poised to perform as inflation continues to drive asset prices higher despite rising rate risks.
Like REITs, closed-end funds trade independently of their net asset value. Shares trade freely on the basis of purchases and sales unrelated to the underlying value of the portfolio. Since RFI is made up of publicly traded REITs, calculating the fund’s underlying value is relatively easy. This means that enthusiasm can drive RFI above its book value and likewise pessimism can lead to an unreasonable retreat.
RFI is a well-established closed-end fund. In fact, the fund may even be older than some readers, having floated in 1993. This gives us the advantage of a long track record to benchmark against. Looking back, RFI traded near or below NAV. However, as inflation continues to top recent history, investors are flocking to real estate for protection. The result is an increase in RFI’s valuation, as the fund is now trading at an unusual premium.
As it stands, the fund is trading at a 9.4% premium to net asset value. This means that a purchase today comes at a premium of nearly 10% to the fund’s underlying assets, almost the highest in the last twelve months. Given the history of trading close to net asset value, the premium poses a risk to the fund’s share price. Even as recently as last month, RFI briefly hit NAV. Investors lucky enough to buy enjoyed a 9.4% return above the NAV return.
Although the premium may be a short-term risk, it is overshadowed by the benefits of reliable income. RFI’s consistent and impressive distribution makes the fund an attractive option at almost any price point. Patient investors may choose to wait for a better opportunity to present itself.
RFI is a closed-end fund that has survived several periods of market turbulence. A final thought worth mentioning is RFI’s relatively small AUM. Historically, RQI has been a more popular option as investors have shown more interest in leveraged iteration.
However, given their comparative performance and the inevitable increases in interest rates, RFIs may be more attractive. Smaller assets could pose merger risk if at some point Cohen & Steers chooses to close the fund. However, after nearly three decades, that seems unlikely given the popularity and success of the fund.
Cohen & Steers is one of the few asset managers to focus on real estate. As a result, their three real estate-focused funds have become fan favorites in the market. The returns generated speak for themselves, consistently outperforming their benchmarks. Although today’s price is high, the fund is still worthy of recognition given its success since its inception nearly 30 years ago.