Cohen & Steers Quality Income Realty Fund (RQI) has had a spectacular run so far this year, far surpassing the broader markets. The total market returns are coming in at 41.50%, with NAV total returns sitting at a still appealing 25.54%. This has dramatically decreased the fund’s discount that it traditionally trades at. However, the fund still offers a slight discount of 0.71% for investors to scoop up. And overall, this has been a quality fund with Cohen & Steers being a top fund with expertise in the REIT space. An investor looking at starting a position can be rewarded over the long term. Those wishing to start a position may benefit from starting with a small initial purchase. After all, investors will still collect the monthly 6.84% distribution, allowing them to receive cash to pick up even more shares when we get the opportunity to load up.
RQI has been a fund I’ve covered several times in the past, and I continue to like the fund. This is because it appears that investors are starting to get nervous over the direction of interest rates. The Fed has been starting to hint at loosening monetary policy and decreasing rates. This is even with the U.S. economy doing well. Overall, they are primarily more concerned with the global economy slowing. These issues could creep into the U.S. and the Fed is looking to negate these future threats.
Thus, investors still need income whether they are in retirement or looking to supplement their current income. REITs are traditionally viewed as an appealing choice with consistent and steady cash flow. This cash flow is due to the steady monthly rent that tenants pay to REITs. Additionally, REITs are required to distribute out 90% of their taxable income. CEFs are viewed as an attractive option for income as well. This is because similar to REITs, CEFs have to distribute out 90% or more of their income and 98% of their realized capital gains. So, putting REIT holdings into a CEF seems like a natural fit!
There are a couple of benefits either way that interest rates go. If rates go up, this indicates that the economy is doing well. REITs can then increase rents on their properties.
If rates go down, they become more attractive to investors as sources of income. The lower interest rates have also helped to leverage up REITs as they can take on more debt and purchase more properties.
This debt becomes more expensive during times of interest rate increases though however, then falling back to what was just previously mentioned; this is generally when the economy is doing well. Thus, making it almost a win-win situation.
So, overall REITs can generally perform in either scenario. This is especially for RQI; they hold some quality names. Again, Cohen & Steers has been in the REIT space for a long time with success. The three portfolio managers in the fund joined in 2002, 2003 and 2004. The three managers also all had experience before even joining Cohen & Steers. This puts them in the unique position of seeing the dot com bubble and 2008/09 financial meltdown.
RQI is quite a large fund with $2 billion in total assets. The fund utilizes leverage, currently at about 23% of assets. The expense ratio of the fund is higher than average at 1.63%. This would ideally be lower, but the fund has definitely earned the fees thus far. When factoring in the interest expense of the fund, we arrive at a total expense ratio of 2.17%.
The managers of RQI have flexibility in their strategy as well. The primary objective of the fund is “high current income and secondary objective of capital appreciation.” They attempt to achieve this through “investing in real estate securities” and more specifically “including common stocks, preferred stocks and other equity securities of any market capitalization issued by real estate companies, including real estate investment trusts (REITs) and similar REIT-like entities.”
(Source – CEFconnect)
As we can see, the fund has excellent 10-year returns of 21.13% market return and NAV return coming in at 19.50%. This was helped significantly by this year’s performance and doesn’t seem like it would happen again. The returns are still impressive nonetheless. Even if RQI returns half the returns over the next 10-year period I would be happy, personally.
However, this performance has also come from the wide discount the fund is typically trading at. This shouldn’t be ignored as the fund is now almost at parity to NAV, I would expect this to further diminish the pace of rising like we have seen this year.
(Source – CEFconnect)
The diminishing of the discount to the current 0.71% has made this fund richly valued compared to its historical trading range. This is evident by the 1-year z-score of 2.40! This shouldn’t be discredited completely. That is why I would recommend an investor have a long-term outlook with this fund. It is a core holding for me and I don’t plan to sell unless the structure of the fund was to, for whatever reason, change. I don’t see that happening either. However, that is also why I would suggest a small position at these levels.
(Source – CEFconnect)
The current distribution rate for RQI is at 6.84%. This is a monthly per share amount of $0.08. The NAV distribution rate is similarly 6.82%, as the fund’s share price is almost at par with NAV price. The estimated source of distribution YTD is all from long-term capital gains. This can change though by year-end and is just estimated by the fund at this time.
(Source – RQI Annual Report)
The latest report for RQI is their Annual Report for 2018. We should expect to see a new Semi-Annual report within the next month or so, for the period ending June. However, we can see that last year the fund had about 32% of the distribution covered by NII. This at first glance doesn’t seem so encouraging.
As a REIT fund, we may want to see this to be a little higher, however, the fund has had considerable success with picking companies with growth potential. This could benefit investors as capital gains taxes are lower than ordinary income taxes. Although, when looking at the final tax characterization of the distributions for 2018, it would appear to have been closer to 38% of the distribution classified as income. This is still attractive as 60% of the distribution was still a more favorable tax rate.
(Source – RQI Annual Report)
Additionally, we can see the fund has significant unrealized appreciation in the portfolio. This is even at the end of 2018 being a rocky year for the market, broadly speaking. At the time of release, RQI was sitting at total assets of $1,742,732,539. This has just increased substantially to the now $2 billion. This leaves the fund with a considerable amount of cushion to weather through a pullback and still maintain the current distribution.
(Source – Fund Fact Sheet)
The top ten holdings, as of June 30, 2019 – make up a considerable amount of the assets in the fund. The top holdings make up almost 45% of the assets. There also have been some considerable changes since I first covered the fund.
(Source – CEFconnect)
Most notably, the top holding was swapped out. Perhaps this was for the best as Simon Property Group Inc. (SPG) is the largest retail REIT. As foot traffic continues to slow for shopping malls, my thoughts are RQI managers decided it was time to swap out. SPG isn’t necessarily a bad investment choice but has many difficulties ahead that will impede their growth.
Conversely, American Tower Corporation (AMT) should have the opportunity for considerable growth going forward. AMT is an “owner and operator of wireless and broadcast communications infrastructure.” This company should benefit considerably from the rollout of 5G. The problem with 5G is that the high-frequency waves don’t travel the same distance that 4G was capable of. This will require more cell towers to be erected, which is not a problem for AMT.
Similarly, Crown Castle International Corp. (CCI) should benefit from this same rollout of 5G across the U.S. and is in RQI’s portfolio as well. These two holdings alone make up 11.6% of assets for RQI and should continue to perform well for the fund.
RQI isn’t necessarily cheap relative to its historical trading range. However, I can see an investor starting a small initial position. To load up on the shares I would like to see a little bit wider of a discount than the current 0.71%. Buying RQI now still gives an investor an attractive monthly distribution of 6.84%. This is considerably higher than what you can get from a broader market fund, like the SPDR S&P 500 (SPY). The higher distribution should entice income investors or investors looking to compound their growth through reinvesting this cash. Perhaps an investor may be enticed to reinvest the accumulated cash from RQI – back into RQI when we get a pullback in the market!
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Disclosure: I am/we are long RQI. 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.