The Cohen & Steers Quality Income Realty Fund (RQI) is a high yield REIT fund that has outperformed the REIT sector over a long period of time. However, this track record is misleading as RQI significantly underperformed when REITs suffered losses due to its use of leverage. As a result, RQI is a volatile instrument that negates diversification benefits and is likely to lead to long-term underperformance for retail investors who tend to sell during market crashes. Therefore, investors should be cautious when investing in RQI and consider alternative high yielding real estate picks that are less volatile and offer better long-term results.
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The Cohen & Steers Quality Income Realty Fund (NYSE:RQI) is a wildly popular high yield REIT fund. Much of its legend stems from its track record of outperforming the REIT sector (VNQ) over a long-period of time:
Data by YCharts
However, we believe that this track record is misleading investors, setting them up for long-term disappointment by investing in RQI. In this article, we discuss why RQI is bound to lead to disappointing results for most if not all shareholders and then offer some alternative high yielding real estate picks that will likely deliver more satisfactory results.
Why RQI Is Poised To Disappoint
One reason why we think that RQI is bound to disappoint investors over the long-term is simply because its long-term track record is not nearly as good as it looks in the chart we just shared with you. First of all, if you look at the periods where REITs got pummeled, you will notice that RQI significantly underperformed VNQ each time. The reason for this is simple: RQI – as a closed end fund – uses quite a bit of leverage. As a result, when REIT prices go up, it generally outperforms the broader REIT sector. When REIT prices fall, it generally underperforms the broader REIT sector.
The amplifying effect of leverage is further enhanced by the fact that CEFs are free to trade at deep discounts and large premiums to their underlying NAV. As a result, when REITs are in favor, RQI’s share price generally trades at a higher ratio relative to its NAV, whereas when REITs are out of favor, RQI’s share price generally trades at a wider discount to its NAV. Ultimately, this means that RQI is a pretty volatile instrument, negating much of the supposed diversification benefits that come from holding a large fund like RQI or VNQ for REIT exposure.
Moreover, research has shown that most retail investors tend to vastly underperform the broader market for one simple reason: they become victims of their emotions and tend to sell during volatile market crashes, thereby locking in steep losses and oftentimes missing out on some of the strongest upward moving days that the market experiences. As a result, by investing in leveraged, volatile products like RQI, chances are you are setting yourself up for long-term underperformance. In other words: retail investor beware, buy RQI at your own risk and make certain that you can continue to hold it even during violent market crashes while it is underperforming the broader REIT sector.
Another reason why we think RQI is bound to disappoint is that it is currently trading at a 5.3% premium to its NAV. This is a big problem because it means that investors who buy in now are essentially paying $1.053 for every $1 of assets that RQI owns. This is a big problem because it means that even if RQI continues to outperform the REIT sector over the long-term, chances are that investors who buy in now will still underperform the broader REIT sector because they are starting out with a 5.3% headwind.
Alternative High Yielding Real Estate Picks
Given the reasons we just discussed, we think that most investors would be better off avoiding RQI altogether. Instead, we recommend that investors consider some of the following high yielding real estate picks:
– AGNC Investment Corp. (AGNC): AGNC is a mortgage REIT that invests primarily in agency mortgage-backed securities. It currently yields 8.4% and is trading at a discount to its NAV.– New Residential Investment Corp. (NRZ): NRZ is a mortgage REIT that invests primarily in non-agency mortgage-backed securities. It currently yields 7.6% and is trading at a discount to its NAV.– Starwood Property Trust (STWD): STWD is a commercial mortgage REIT that invests primarily in first mortgages on commercial properties. It currently yields 7.1% and is trading at a discount to its NAV.
Conclusion
Investing in high yield REIT funds like RQI can be tempting for investors seeking income, but we believe that RQI is bound to disappoint over the long-term. Its use of leverage and high premium to NAV make it a volatile instrument that is likely to underperform the broader REIT sector even if it continues to outperform in the future. Instead, we recommend that investors consider some of the alternative high yielding real estate picks we discussed, such as AGNC, NRZ, and STWD, for more satisfactory results.
