Cheap Real Estate Still for Sale in Closed-End Funds

 | Jul 13, 2016 | 12:00 PM EDT
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Yesterday I talked about using real estate as a way of finding income in these yield-starved times. While it is true that most people are underexposed to real estate and that real estate investment trusts have handily outperformed the broader market over the past 43 years, many REIT prices have been driven to extremely high levels. It is harder now to find REITs that trade at bargain levels.

So to put money to work in real estate securities at a good price you must dig a little deeper.

If we turn to the closed-end fund world we can find REITs at bargain prices. Most of the real estate sector closed-end funds are trading at a discount, offering a chance to buy these names at 10%, 15% and even 20% off current net asset values.

Over the years I have done very well buying closed-end funds at a discount and I see no reason it won't work with real estate income funds. We should be able to buy REITs at a sizable discount and just collect dividends and enjoy the growth of the underlying portfolio over a long period. If popularity or activist activity drives the shares to a premium we can then consider selling them for a sizeable gain.

The name with the deepest discount is RMR Real Estate Income Fund (RIF) , which is managed by RMR, a company controlled by Barry and Adam Portnoy. The last time we ran across this father-and-son duo they were having control of what is now Equity Commonwealth (EQC) wrested away from them by activist investors.

The activists accused the Portnoys of enriching themselves at shareholder expense and easily won the vote and control of the REIT. This was not the first time these types of accusations have been made and as a result investors have shunned many of their deals. The unpopularity of the Portnoys appears to be a primary reason for RIF's current 21% discount to net asset value.

RIF's portfolio is actually a fairly well-diversified mix of various types of REITs. Lodging, health care and apartments are the three largest sector holdings and account for about 35% of the total portfolio. If the REITs in the package were to fall 21% anytime soon I would be a buyer of many of them and this fund gives me a chance to buy them at a big discount.

Although the Portnoys might not be too concerned about closing the NAV gap, between father and son they directly own about 9% of the shares so they are paying attention to total return. In fact, RIF has outperformed its peer group over the past five years. The current distribution rate is 6.8% so it's a decent income choice.

CBRE Clarion Global Real Estate Income Fund (IGR) is also an interesting choice right now. The fund invests in income-producing real estate securities located mainly in the developed markets of North America, Europe, Australia and Asia. Currently, about 20% of the fund is invested in the U.K. and Europe, which is intriguing given the steep selloff in REITs in those areas as a result of the Brexit vote. Retail and industrial REITs make up about half of IGR's current portfolio. Also, the fund has about 13% in U.S. REIT preferreds, which should do well in a "lower-for-longer" environment.

The fund is managed by the investment management arm of global real estate powerhouse CBRE Group CBG, so management should have some insights into global property valuations.

IGR is trading at a 15.9% discount to net asset value and has a distribution yield of 7.33%. The discount to net asset value is well above both the five- and 10-year averages so there should be some reversion to the mean that helps lift the share price and combines with the attractive yield for a solid total return. What's more, the fund has a very strong institutional shareholder base that could well push management to take steps to narrow the discount if it gets too large.

Closed-end funds offer income-seeking investors an opportunity to buy REITs at an attractive discount. It is not only a short-term strategy, but long-term patient shareholders should collect a lot of dividends and see appreciation over time as well.

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