RQI: Quality REIT Exposure With An 8.6%+ Distribution Yield (NYSE:RQI)

Written by Nick Ackerman, co-produced by Stanford Chemist.

Actual property funding trusts (“REITs”) are persevering with to face strain on this present rate of interest surroundings. Yields had risen considerably by way of August, and that put additional strain on this sector of the market. As yields develop on risk-free investments, income-oriented REITs change into much less engaging. Moreover, rising charges imply larger prices on the subject of financing new progress.

That being stated, REITs are additionally now attractively priced and have been crushed down loads for these causes already. One fund to realize entry to a pool of REIT and actual property investments could be the Cohen & Steers High quality Revenue Realty Fund (NYSE:RQI). In my view, Cohen & Steers is the top-tier REIT supervisor within the closed-end fund house. This fund presently sports activities a stable low cost, which implies you might be getting a pool of REITs at a bit cheaper even.

The Fundamentals

• 1-Yr Z-score: -0.95
• Low cost: -7.08%
• Distribution Yield: 8.61%
• Expense Ratio: 1.39%
• Leverage: 29.24%
• Managed Property: $2.43 billion
• Construction: Perpetual

RQI’s funding objective is to offer a “excessive present earnings.” Additionally they have a secondary funding goal of “capital appreciation.” They may put money into “actual property securities together with widespread shares, most popular shares and different fairness securities of any market capitalization issued by actual property corporations, together with actual property funding trusts (REITs) and related REIT-like entities.”

The fund’s complete expense ratio comes to three.79%. We have seen this rise considerably as a result of leverage bills rising on their underlying debt. Final fiscal yr, the entire expense ratio was at 2.33%. Nevertheless, whereas the expense ratio is rising resulting from elevated borrowing prices, they’ve additionally been experiencing positive factors of their rate of interest swaps to offset this damaging.

Cohen & Steers is among the administration teams that hedged nearly all of their leverage by way of rate of interest swaps. This locked within the majority of their borrowings at a price of 1.7%, whereas the variable price is available in at 6%. That 6% is what different friends must eat throughout their whole pool of borrowings in the event that they did not hedge.

This hedging will fall off over the following few years, however that is perhaps simply sufficient time. The Fed is anticipating that they’ll have to cut rates in 2024 and 2025, which might be excellent timing for RQI administration to lock in decrease charges as soon as once more. In fact, that is solely an estimate, and issues may change shortly in both route relying on how the economic system strikes going ahead.

Efficiency – Engaging Low cost

Within the CEF house, RQI is a somewhat massive fund coming in at complete managed property of over $2.4 billion. Nevertheless, this does come from the numerous leverage that we mentioned above. The fund makes use of this leverage in an try and generate additional positive factors for its shareholders. The draw back on this case, in fact, is that it might additionally go in opposition to shareholders throughout robust occasions for REITs, equivalent to we’re in now.

That being stated, if we take a look at the interval from the start of 2022 to immediately, RQI’s leverage appeared to haven’t any damaging impression additional than investing within the simple Vanguard Actual Property ETF (VNQ).

In actual fact, if we wished to get choosy, we will see that on a complete NAV return foundation, RQI has barely crushed out VNQ throughout this era. It was on a complete share value return that the fund lagged behind VNQ, and that is because the fund was buying and selling close to parity with its NAV, and now a reduction has opened up.

Over the long run, RQI has crushed VNQ as nicely. That was at a time when rates of interest had been close to 0%, so I would must assume that actually helped. Regardless of larger rates of interest now, as we touched on above, the Fed really expects to chop charges subsequent yr and the next from the present ranges. Something can actually occur, however that bodes nicely for RQI.

Then once more, it must be famous that RQI is not solely centered on fairness REITs. Additionally they incorporate some most popular and fixed-income publicity that makes it a bit extra of a hybrid strategy.

The fund’s low cost has narrowed from the low cost lows we noticed earlier this yr. Nevertheless, we imagine that any low cost wider than 5% represents a shopping for alternative. This represents a reduction near its five-year common.

Distribution – Wanting Secure

Given the present surroundings of extremely poor efficiency in 2022 and pressures in 2023, although not practically as unhealthy, I believe a primary query could be if the fund’s distribution is protected. Properly, given what we all know for now, I imagine that it’s protected even on this strain the place REITs are dealing with strain. The NAV distribution price comes to eight%, and I do not imagine that’s at an unreasonable stage. So I think that the present $0.08 month-to-month distribution that they’ve paid for years now is not going anyplace.

That is not to say that if we get right into a deep recession or one other black swan occasion happens, they will not reduce; in that case, something may occur.

Going again to the leverage dialogue rising the bills of the fund, we see that play out with the fund’s internet funding earnings (“NII”). If we annualized the per-share determine, it will come to $0.20 in comparison with final yr’s $0.30.

Modifications can happen on a regular basis with lively administration shopping for and promoting the underlying portfolio. Nevertheless, one other important impression is bills rising. As bills rise, that’s subtracted from the entire funding earnings (“TII”) of the fund.

NII, for many who could also be newer to investing, is solely the TII minus bills. To get TII, it’s the sum of all of the dividends and curiosity funds from RQI’s underlying portfolio.

On this newest report for the final six months, that they had a TII of $44.541 million. From the identical period a year ago, the fund’s TII was really solely $35.193 million. So TII elevated 26.56%, however NII decreased 14.45%.

Whole bills final yr for the primary six months of the yr got here to $20.172 million, and people ballooned to $31.69 million in the identical interval this yr. The first driver was the curiosity bills, rising to $20.082 from $12.044 million.

That is actually substantial, however that enhance was really solely offset by a capital achieve ensuing from the fund’s rate of interest swap contracts. Which is the place these offsets come from. The bills nonetheless enhance, and that can present a NII lower; nonetheless, it’s coming from capital positive factors from the rate of interest swaps that offset that as its hedge.

Which means NII can lower, however they will nonetheless be left ready the place protection of the fund’s distribution does not really get negatively impacted. The bucket of the place protection comes from simply shifts.

The fund has additionally efficiently produced positive factors from writing choices as nicely. They don’t seem to be essentially probably the most significant positive factors on this interval, however they’re there. Sadly, these positive factors had been greater than offset by the unrealized losses from choices writing for this era.

For taxes, we mentioned these earlier this yr:

For the tax classification for 2022, RQI’s distribution was principally capital positive factors. That may be helpful as it’s usually tax-friendlier than abnormal earnings. Though, non-qualified earnings for RQI remained substantial, as is commonly the case with REITs.

RQI’s Portfolio

Within the first half of the yr, the administration has been fairly quiet by way of making strikes; the turnover of the portfolio solely involves 9%. That places it on pattern to have the bottom turnover within the final 5 years if it continues.

A further worthwhile observe for this fund is that it carries 79% to fairness REITS, and the opposite 21% is most popular and stuck earnings publicity. That is in keeping with what we often see for this fund. Nevertheless, they really place a lot bigger bets on their fairness holdings relative to their fixed-income sleeve.

They checklist a complete of 227 holdings as of the tip of June 30, 2023. The fairness names simply counted of their final semi-annual report at 31 of those positions, which means all the remainder of the 196 holdings are divided amongst the popular and bonds.

This interprets out right into a excessive focus of prime holdings, with the highest ten really making up simply over 50% of the whole portfolio. The final replace additionally got here in with a virtually equivalent 50.4% weight. That actually hadn’t harm their efficiency, although, when evaluating it to VNQ, as we noticed above within the larger rate of interest surroundings.

Increased focus may end up in a neater likelihood to outperform friends, but it surely additionally means the next likelihood to underperform as nicely. It comes down to every particular person place being extra impactful, for higher or worse.

In trying on the newest prime ten, it is not overly totally different from what we noticed in our earlier replace. The one change we see right here is that Crown Citadel Inc. (CCI) is now within the prime ten, which pushed Public Storage (PSA) decrease. Nevertheless, PSA stays a place within the fund.

As we’d count on, with the biggest holdings remaining largely unchanged and the fund reporting low turnover, the sector allocations have remained pretty static too.

Conclusion

RQI is a stable REIT-focused fund that invests closely in fairness REITs but additionally sports activities some fixed-income publicity. The fund is leveraged. Nevertheless, the fund wasn’t adversely impacted once we examine it to VNQ throughout the rising rate of interest surroundings beginning in the beginning of 2022. That was whilst its borrowing prices had elevated considerably; this is able to be due to the fund’s hedging by way of rate of interest swaps that they carried out. That meant that the rising borrowing prices had been greater than offset by positive factors in these contracts.

That additionally signifies that regardless of NII slipping with this newest report, the distribution protection hasn’t actually modified. Solely the bucket from which it’s being lined has shifted. In fact, this nonetheless signifies that the distribution would require important capital positive factors shifting ahead. Any form of black swan occasion or deep recession may trigger some stresses the place we may see a reduce, however for now, it appears fairly protected.

The fund can also be buying and selling at a horny low cost, making it a fantastic time to contemplate this fund for a long-term investor to realize some actual property publicity. The largest headwinds for this fund stem from rising rates of interest. The most recent estimate is the anticipated decrease charges within the subsequent couple of years; these headwinds may flip to tailwinds.