Closed-End Funds: Balanced by Modest Supply Growth

The wider financial crisis buffeted closed-end real estate funds every bit as much in 2007 as other real estate funds, but they may regain some ground in 2008 as investors come to the conclusion that fundamentals didn’t suffer that much. However, a slower U.S. economy is currently a wild card. Even so, “going forward, there might be weaker demand for some kinds of real estate, but balanced by more modest supply growth,” notes Steven Brown, managing director of Neuberger Berman. “If GDP moves up later this year, fundamentals could improve quite rapidly.”

Certainly closed-end funds took it hard on the chin, but it also needs to be said that the declines among closed-funds last year generally came in the wake of extraordinary gains in 2005 and 2006. Thus, the funds came down from a peak, rather than deep into a trough, Brown continues.

Of the 24 closed-end real estate funds tracked by Lipper, none showed a positive return last year. On average, closed-end real estate funds declined an average of 25.84 percent.

In other words, the best closed-end funds in 2007 were those that dropped the least. Four funds were down less than 10 percent: Cohen & Steers REIT & Utility Income Fund Inc. (XRTUX), RMR Asia Pacific Real Estate Fund (XRAPX), Neuberger Berman Dividend Advantage Fund Inc. (XNDDX), and Cohen & Steers Dividend Majors Fund Inc. (XDVMX).

The leader, XRTUX, declined only 1.15 percent in 2007. The reason for its relative health seems to be that it holdings are long on utilities. Of its top-10 holdings, in fact, only one is a REIT—Nationwide Health Properties Inc. (NYSE: NHP), whose health care property sector did better than most real estate last year. The rest of XRTUX’s major holdings include the likes of Duke Energy Corp., Progress Energy Corp. and Exelon Corp.

A closed fund mostly focusing on real estate was RMR Asia Pacific Real Estate, down 2.99 percent for the year. Its major holdings read like a who’s who of Asian real estate, including Mitsubishi Estate (TSE: 8306.05) and Sumitomo Realty (TSE: 830). While North American and European real estate markets were in the doldrums in the second half of 2007, Asia did comparatively well.

Neuberger Berman Dividend Advantage Fund, down 6.37 percent, holds mostly domestic REITs, including those that have fared the current environment relatively well, such as the Manhattan office specialist SL Green Realty (NYSE: SLG) and international industrial ProLogis (NYSE: PLD). XNDDX did, however, leaven its portfolio a bit with Freeport McMoRan Copper & Gold. Cohen & Steers Dividend Majors Fund (XDVMX), down 9.51 percent, also holds a chunk of SL Green Realty and a few other REITs, but is more diversified, holding large amounts of communications, pharmaceutical and other stocks.