RNP: Consistent 8% Income Yield And Potentially Market Matching Returns

Introduction

Cohen & Steers REIT & Preferred Income Fund (NYSE:RNP) is a closed-end fund incepted in Jun. 2003. The fund has a pretty successful record of 21 years. The fund is a hybrid fund and primarily invests in the equity of Real-estate companies, including the REITs (Real Estate Investment Trusts) and diversified preferred and fixed-income securities. Currently, the fund is invested roughly 48% in common equity and 52% in preferred and fixed-income securities. The majority of investments are in U.S. companies, but the fund also invests globally, especially in Canada, the U.K., European countries, Australia, and Japan.

As per the fund’s literature, “The primary investment objective of the Fund is to seek high current income through investment in real estate and diversified preferred securities. The secondary investment objective is capital appreciation. Real estate securities include securities of any market capitalization issued by real estate companies (including REITs), and preferred securities are issued by U.S. and non-U.S. companies.“

Other salient features of this fund are as follows:

• The fund is managed by the Cohen & Steers fund family, which is a well-respected name in real estate, infrastructure, and alternative investments. They have 35 years of experience and have several funds with long histories of success and providing sustainable income.
• The fund RNP uses roughly 31% leverage. As most readers know, leverage can work both ways. In a bull market and low-interest rates environment, it can be helpful in boosting income and returns, but it can also hurt the performance in a bear market. In addition, in a high-rate interest environment, it can add a lot of additional interest burden that cuts down on the overall returns. For the past two years, we have been in an environment with high-interest rates, and that has certainly hurt this fund. However, we seem to be at the peak interest rates, and almost everyone is expecting the rates to decline, which bodes well for the fund.
• The fund has an excellent past record of long-term performance. However, the past two years have been turbulent, and 3-year performance has been mediocre at best. Longer term, as of Dec.31, 2023, since inception in 2003, the fund has returned 12.93% on NAV basis, annualized, compared to 10.19% for the S&P500. Based on market prices, it has returned 10.85%, 11.11%, and 4.65% over 10-year, 5-year, and 3-year timeframes, respectively. These results assume that all distributions were reinvested.
• The fund pays a monthly distribution. It also follows a ‘managed’ distribution policy, which would mean that the fund may not always earn enough in investment income and capital gains and pay some of the distribution as ROC (return of capital). However, in the last four years, there was zero ROC.
• The funds’ mandate allows it to invest globally, but it is invested nearly 60% in U.S.-based companies or securities.
• It is a reasonably diversified fund and has a total of 316 holdings (as of Dec.31, 2023). However, on the equity side (which is 48% of the fund’s assets), it is invested in roughly 40 companies.
• As of Jan.31, 2024, the fund under its management had roughly $1.4 billion in total assets, including the leverage.
• The fund is an actively managed fund and has an expense ratio of 1.10% on the managed assets. In addition, the interest expense is roughly 1.2%. However, during the first half of 2023, the interest expense shot up to 2.57% on NAV basis (and 1.8% on a total-asset basis).
• As of Jan.31, 2024, its distribution yield on the market price was 8.10% and 8.07% on the NAV.
• As of Jan.31, 2024, RNP’s market price offered a very small discount of -0.40% to its NAV. The 3-year average premium/discount is -2.69%, and the 6-month average is only -4.31%.

How does the Fund compare with its benchmark or similar funds?

The fund follows two benchmarks. This fund is 50% equity and 50% preferred securities. So, it is appropriate to account for both components. The fund uses the following indexes for benchmark purposes.

• FTSE NAREIT All Equity REIT Index
• ICE BofA Fixed Rate Preferred Index

However, it is difficult to find equivalent ETFs for these indexes, which also have long histories.

We will compare RNP with the following two ETFs and the S&P500.

• iShares U.S. Real Estate ETF (IYR) 50%
• iShares Preferred and Income Securities ETF (PFF) 50%

Chart-1:

As we can observe, RNP has returned almost comparable to S&P 500, even though it underperformed in 2022 and 2023. Also, it had a more severe drawdown in 2008-2009 compared to the S&P 500.

Further, RNP is especially attractive if you are withdrawing the income on a regular basis.

Financial Outlook

Let’s look at the Fund’s Financial health and performance. The most recent detailed report that is available to investors is the semi-annual report for the period of Jan. 2023 – Jun. 30. 2023, and the annual report for the year 2022. The annual report as of Dec.31, 2023, is already due but is not available yet.

Net Investment Income

The net investment income (or NII in short) is the net income that a fund earns from its investment in the form of dividends, distributions, and interests or derivatives like options, minus all of the fund’s expenses, including management fees, operating expenses, commissions, and interest on leverage, etc. For equity-based funds, especially in high-growth sectors like technology, the NII is not very relevant. However, for fixed-income or bond funds, it is highly relevant. In the case of RNP, it has real-estate equity and 50% preferred and fixed income. Also, most of the real-estate equity stocks or REITs provide generous yields. So, it does generate a substantial amount of income. However, some of that goes into paying for expenses, including the management fee. Also, since this fund carries a substantial amount of leverage, there is quite a bit of interest expense. We will see in the below table that the interest expense nearly doubled in 2023 compared to 2022. However, if we take the last four year’s average, after all expenses, the NII pays about 35% of the fund’s distributions. The rest is paid from capital gains, mostly long-term capital gains. In the year 2022, the fund also paid a large amount in a year-end special dividend.

Here is what it looks like in terms of NII, Distributions, and Net Assets at the beginning and end of the statement period.

(all amounts are in US $ (except Shares Outstanding); negative amounts are shown inside parentheses, per the Semi-annual report, six months ending Jun. 30, 2023, and the Annual report, 12 months ending Dec. 2022). However, we recognize that it is not a one-to-one comparison because of the asymmetry in the two reporting periods. However, per share data, the period is not relevant.

Table-1:

Data source: RNP’s 2023 6-Months-Report and 2022 Annual Report.

Distributions

RNP provides a monthly distribution of $0.1360 per share, which comes out to be a yield of 8.10% at current prices (as of 01/31/2024) and 8.07% on the NAV. The fund follows a ‘managed’ distribution policy. That means it tries to keep the distribution rate fairly consistent. The fund increased the distribution by 9.67% in early 2021, and since then, it has kept the same distribution. However, it may be noted that it did reduce the distribution amount during the 2008-2009 financial crisis.

So, is the distribution covered?

Table-2: Distribution (from 2020-2023)

Data source: Fund’s Literature.

The regular distribution amount is $1.6320 for the year ($0.1360 a month); however, the fund paid a special distribution of $1.0714 in Dec.2022. We checked the distribution record for the last four years and found that no ROC (return of capital) was paid during this period. That is a pretty good record on this front, as the years 2022 and 2023 have been really tough on the fund due to high-interest rates.

That said, the fund depends on good years to generate capital gains to sustain the dividends. As long as the down cycles are not multi-year prolonged ones, this fund should do just fine.

Since its inception over 20 years ago, the fund has gone through many market conditions and many upheavals. As stated earlier, they did cut the distributions in the 2008-2009 cycle, but other than that, they have a pretty good record. We can rate the dividend reliability as pretty strong.

Discount/Premium

The fund is currently trading at a very slight discount of -0.40% (to its NAV, as of Jan. 31, 2024); however, it has traded at a larger discount of -2.69% over three years.

We present below the three-year history of premium/discount. The fund has spent most of its time in the discount area. Currently, it is nearly flat. So, patient investors could wait for it to offer a reasonable discount similar to its past. However, we should always look at both the premium/discount and the overall valuation of the fund within its sector.

Chart-2: RNP – Premium/Discount Chart (over three years)

Courtesy: CEFConnect.com

Fund’s Holdings

First, the fund is a hybrid fund and mixes two asset classes in almost equal proportions. It is 50% real-estate equity and the other 50% preferred and fixed-income securities. In terms of holdings, the fund is very diverse, as the number of holdings stood at 316 as of Dec. 31, 2023. That said, most of the diversification is in the preferred and fixed-income securities. On the equity side, the number of equity holdings is under 40, many of them are well-known REITs. We also observe that it is concentrated in the top 10 equity holdings as they account for slightly over 30%. The top 10 holdings as of Dec. 31, 2023, and asset composition are presented below. Some of the top equity holdings are American Tower (AMT), Prologis (PLD), Welltower (WELL), Simon Property (SPG), Invitation Homes (INVH), Digital Realty (DLR), and Realty Income (O).

Table-3:

Courtesy: SeekingAlpha

Chart-3:

Performance and Valuation

If you are looking for consistent and relatively reliable high-income and decent total returns over the long term, you are looking at the right fund. In fact, over the long term, RNP has nearly matched the performance of the S&P500 in terms of total returns, though it would depend on which year you started the investment. The recent performance, especially in the last couple of years, fund’s performance is far below that of the S&P 500.

In the table below, we compare several performance-related metrics with other funds and the S&P 500. We have also included a ‘Blended’ hypothetical benchmark (with 50% VNQ and 50% PFF). The following are included:

• RNP
• Blended CEF (50% JRS, 50% JPC)
  • Nuveen Real Estate Income Fund (JRS)
  • Nuveen Preferred & Income Opportunities Fund (JPC)
• Blended fund (50% VNQ, 50% PFF)
  • Vanguard Real Estate Index Fund ETF (VNQ)
  • iShares Preferred and Income Securities ETF (PFF)
• S&P 500 (SPY)

Table 4: (Data – period as specified, otherwise as of Jan. 31, 2024)

Click to enlarge

Note: Some of the data (e.g., number of holdings and leverage) may not be current as of Jan. 31, 2024.

Now, the past performance looks decent, especially the long-term past performance. In fact, it has outperformed the S&P500 since its inception date, both in terms of NAV and market price. The only negative is the high amount of leverage. Even then, the management has done a reasonably good job of maintaining the funds’ NAV over 20 years. As such, the current NAV is below the inception NAV, but that is compensated by the fact that the fund has paid large amounts of special dividends a few times.

However, investments are about the future, not the past. That said, for funds like RNP, past performance tells a lot about the future as long as the management’s focus remains the same. The past couple of years have been tough on fixed investments as well as the real estate sector due to the high-interest rate regime. For funds with leverage, it was a double whammy.

However, in the last couple of months, there have been high expectations of normalization of interest rates, meaning the rates should decline from here. That is the reason we saw a gain of 25% for the real-estate ETF VNQ during the last two months of 2023 before losing some steam. If, for some reason, the rates stay high for longer, we will see serious headwinds for funds like RNP.

Risk Factors

Investors need to be aware of certain risk factors that are associated with this fund and CEFs in general. Risk factors could be summarized as follows:

• RNP’s near to mid-term future performance may be impacted by the movement of interest rates. However, as of now, all indicators and expectations are pointing to interest rates going down in 2024. This will help boost the valuations in the real estate sector as well as for preferred securities. Also, since this fund carries substantial leverage, there is a large impact on the interest expense.
• If high-interest rates somehow were to rise from here or stay higher and longer than expected (there is at least some possibility), then that would be a real headwind for this fund.
• This fund is more volatile compared to the S&P500, likely due to 32% leverage.
• The general risks such as the geo-political situation.
• The possibility of occurrence of a recession in 2024, though most market participants are expecting a shallow one if that happens.

Concluding Thoughts

If you are a retiree or less than five years away from retirement, and you need your capital to earn you 8% plus income yield, then RNP may deserve a place in your income portfolio. This fund has a proven record of paying consistent dividends for many years and maintaining its NAV all this while. On a total return basis as well, it has an excellent record. Sure, past records do not guarantee anything, but they do inspire a level of confidence in the management’s ability to steer it through thick and thin. Also, the fund has a low correlation with the S&P500, so it offers great diversification in alternative assets.

With regards to valuation, it is fairly valued. On the NAV basis, the fund does not appear to be expensive, and the NAV is likely to go higher in 2024 as long as interest rates decline. It offers no discount at this time. So, as an investor, you should tread the water carefully and not go all in at this stage. If you are a new buyer, you could buy the first lot of shares as a placeholder and buy more whenever the opportunity appears. The existing owners should hold the shares as we consider this to be a long-term holding that should serve its owners well.