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COHEN & STEERS SPECIAL EQUITY FUND, INC.
October 20, 1999
To Our Shareholders:
We are pleased to submit to you the report for Cohen & Steers Special
Equity Fund for the quarter and nine months ended September 30, 1999. The net
asset value per share on that date was $20.73. Regular dividends are reviewed
semi-annually; therefore, no dividend was declared for the quarter. The Board of
Directors will review the next regular dividend in December.
INVESTMENT REVIEW AND OUTLOOK
For the three months ended September 30, 1999, Cohen & Steers Special
Equity Fund had a total return of -10.1%, which compares to the NAREIT Equity
REIT Index total return of -8.0% and the Standard & Poor's 500 Index return of
- -6.3%. Year-to-date through September 30, 1999, the Fund had a total return of
- -0.4%, compared to the NAREIT Equity REIT Index return of -3.6% and the
Standard & Poor's 500 Index return of 5.4%.
The past two years have been perhaps the most challenging ever for REIT
investors. Unlike the case with previous bear markets, fundamentals seemingly
have not turned negative -- in fact it appears that fundamentals are more
positive today than at any time in nearly two decades. Vacancy rates are low,
property prices have recovered, the economy continues to support strong demand
for space, and there are only few signs of speculative new construction. Yet,
the shares of REITs and other real estate companies are as cheap as they have
ever been, based on nearly every valuation measure, including price/cash flow
multiple, dividend yield and price in relation to asset value. These seemingly
contradictory trends raise some important questions, which we would like to
address in this report.
1. JUST WHERE ARE WE IN THE REAL ESTATE CYCLE?
It appears to many that we are at or near the peak of the real estate
cycle. Following the strong recovery of the 1990's, nearly every property type
in nearly every major market appears to be at equilibrium, meaning that supply
and demand for space are about equal. Rental rates for most major property types
are at a cyclical high, and property prices are generally close to replacement
cost. This makes new construction feasible. While some exceptions certainly
exist, direct buyers of property today can typically expect returns that reflect
little more than current net rental income plus some growth approximating the
rate of inflation.
That the cycle is close to its peak may be the most obvious reason for the
market's low valuation of REITs. The strong recovery and sound fundamentals
indicate that the health of the real estate industry could not be better.
Indeed, if we are at a peak in the cycle, then the next phase may well be a
decline. Such a decline could be the result of a surge in the supply of space,
or a decrease in demand due to an economic slowdown, or some combination of
both. In such an environment, vacancy rates would likely rise and property
values would likely fall. As a result, and as is the case with many other
cyclical industries, the market tends to value peak earnings at low multiples.
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COHEN & STEERS SPECIAL EQUITY FUND, INC.
2. IF REAL ESTATE MARKETS ARE AT THE TOP OF THE CYCLE, HOW IS IT POSSIBLE TO
MAKE MONEY IN REAL ESTATE STOCKS?
While it may have become more difficult to earn above-average profits in
real estate, we believe that an investment in REITs may still be rewarding due
to several factors. First, based on current valuations, it appears that REITs
already reflect any potential downside in the cycle. Because the capital markets
move in anticipation of events, rather than in reaction, we would not be
surprised to see REITs perform better even in the face of flat or deteriorating
fundamentals. Such has indeed been the case in previous real estate cycles. As
shown in the following chart, there is a highly cyclical pattern to capital
raising in the REIT industry: more capital is raised when the stocks are
expensive, and less is raised when they are cheap. It is notable that following
the trough in the capital cycle, total returns from REITs have been exceptional.
We believe that we are currently at or near the trough of the current capital
raising cycle. While past performance is no guarantee of future results, under
this scenario there is a strong possibility that better returns lie ahead.
REIT EQUITY ISSUANCE AND INVESTMENT RETURNS
<TABLE>
<CAPTION>
12-Month
12-Month Total Return.
Total Equity NAREIT Equity
Date Issuance REIT Index
- ----- ------------ -------------
($ Billions)
<S> <C> <C>
3/90 $ 0.6 2.2%
6/90 0.5 -3.5
9/90 0.3 -20.5
12/90 0.3 -15.4
3/91 0.3 8.1
6/91 0.4 9.1
9/91 0.4 32.8
12/91 0.5 35.7
3/92 0.7 11.3
6/92 0.9 13.3
9/92 0.9 16.3
12/92 1.4 14.6
3/93 2.7 38.5
6/93 4.3 31.0
9/93 8.1 34.1
12/93 13.2 19.7
3/94 14.9 1.7
6/94 16.7 6.6
9/94 15.9 -4.5
12/94 11.1 3.2
3/95 8.9 -0.4
6/95 8.1 3.6
9/95 6.7 10.7
12/95 8.2 15.3
3/96 8.9 18.1
6/96 8.4 16.5
9/96 9.8 18.5
12/96 12.3 35.3
3/97 16.5 33.2
6/97 20.5 33.8
9/97 26.1 40.5
12/97 32.7 20.3
3/98 35.6 18.9
6/98 36.2 8.0
9/98 29.4 -13.5
12/98 21.5 -17.5
3/99 14.0 -21.1
6/99 8.5 -9.0
9/99 8.3 -6.5
12/99 6.2 0.0
</TABLE>
Sources: NAREIT, Cohen & Steers
Second, and perhaps more importantly, is that based on changes in the way
real estate is financed, there may not be major downside from here, in our
opinion. There continue to be rolling corrections in markets where a surge in
building has taken place, with financing and construction almost spontaneously
receding when hints of overbuilding surface. Thus, barring a major economic
dislocation which materially reduces the demand for space, we believe that both
real estate and REITs may continue to enjoy stable fundamentals.
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COHEN & STEERS SPECIAL EQUITY FUND, INC.
3. WHAT PREVENTS REITs FROM GETTING CHEAPER? WHAT WILL MAKE THEM TURN AROUND?
There is nothing to prevent REITs from getting cheaper, just as there was
nothing to prevent them from getting as cheap as they currently are. However,
with most of the valuation parameters that investors have used in the
past -- such as absolute and relative price/cash flow and dividend yield, and
share price to net asset value -- at or near unprecedented levels, it is hard to
envision a great deal more downside risk. In many instances, REIT share prices
have reached levels that have already invited takeover or going-private
transactions. We would expect to see a growing amount of this activity if prices
stay as low as they are today. Other potential positive catalysts: rising
inflation (because of real estate's inflation hedge characteristic), a
correction in the valuation of the broader stock market (due to REITs' lack of
correlation with other financial assets), or a change in investment sentiment in
favor of current income (due to the superior current dividend yield of REITs).
In any case, because it is nearly impossible to predict exactly what will spark
a move in any group, we believe it is more constructive to focus on finding the
companies with the strongest and most reliable fundamentals, and own them at
attractive valuations.
4. HOW WILL THE GROWTH OF THE INTERNET AFFECT REAL ESTATE MARKETS?
So far, the only tangible effect of the Internet on REITs has been the
diversion of capital away from REIT stocks and into Internet stocks. This,
however, is in the process of changing. Internet retailing is making many
inroads that will surely have an impact on some sectors of the shopping center
industry. Our view is that the apparel-oriented regional malls will be less
affected than shopping centers that sell more commodity-like consumer products.
Distribution channels are changing, which is impacting warehouse and industrial
facilities. Companies that have strong relationships with manufacturers and
Internet-based retailers are better positioned to benefit than those that merely
own ordinary space. Finally, office space usage is changing as is the range of
services required by office tenants. High speed telecommunication and Internet
access, for example, is becoming a new profit center for office landlords.
5. IS THIS THE END OF REAL ESTATE SECURITIZATION?
Real estate securitization remains in the early phase of a long-term
expansion. Our view is that the current low valuation level of REITs is a
cyclical issue, not a change in the secular dynamics driving real estate
finance. The benefits of securitization remain in place. They include liquidity,
real-time pricing, professional management, improved disclosure and alignment of
shareholder and management interests. The real estate securities market also
offers investors a means to create a real estate portfolio best suited to their
needs. Debt securitization continues to be active, with over $60 billion of real
estate debt securities issuance expected this year. Growth in real estate equity
securitization has been modest this year, reflective of difficult equity
markets. The decline in equity issuance, however, demonstrates that the public
capital markets act as a governor on real estate activity.
6. ARE THERE CAPITAL APPRECIATION OPPORTUNITIES AT THIS STAGE OF THE REAL ESTATE
CYCLE?
Investors in income-producing real estate realized a substantial amount of
capital appreciation over the past seven years. Looking forward, however, we
believe that a greater proportion of real estate returns should be derived
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COHEN & STEERS SPECIAL EQUITY FUND, INC.
from current income. Notwithstanding this real estate environment, we still see
investment opportunities that meet the Fund's capital appreciation objective.
First, it is important to note that the Fund has a broader universe than the
average 'REIT-only' mutual fund, which gives us greater flexibility to invest in
many types of real estate-related businesses. For example, one of our largest
holdings is Reckson Services, a company that is providing broadband Internet and
telecommunication services to office tenants, a market with significant growth
potential. In addition, we believe that the cycle for health care-oriented real
estate is not only out of phase with the general real estate cycle but is
bottoming, thereby creating capital appreciation opportunities. Finally, we
still see opportunity for capital appreciation in REITs, whose returns are
generated primarily by income property performance, because the average company
is trading at a 15% discount to asset value. The Fund's reliance on capital
appreciation can be measured by the gross dividend yield on equities, currently
2.1% versus 8.5% for the average REIT. We believe that capital appreciation
potential is worth the sacrifice in current yield; however, as presently
structured the Fund could under-perform REITs in general if investment sentiment
toward current income improved, or if the broader stock market were to decline.
7. HOW CAN YOU MAKE MONEY IN THE HEALTH CARE SECTOR?
We have identified the health care sector as an area that is situated for
opportunistic investment, and have 26% of the Fund allocated to these
situations. The stocks in this sector -- specifically the nursing home and
assisted living segments -- have been significantly de-valued, reflecting
deteriorating fundamentals and financial distress. To us, the health care sector
is analogous to the opportunity afforded to real estate investors when the
Resolution Trust Corporation ('RTC') was established in the early 1990's to
'work out', or restructure and dispose of, real estate assets that U.S.
financial institutions owned via foreclosure.
By way of background, both nursing homes and assisted living experienced
periods of dramatic expansion, one via acquisition and one via development,
which collided with a negative change in business fundamentals -- a regulatory
change that reduced Medicare reimbursement for nursing homes, and overbuilding
in the assisted living sector. The nursing home sector is furthest along in the
recovery process, having absorbed the bulk of the reimbursement hit, and having
announced the first wave of balance sheet restructuring. The assisted living
sector is earlier in the recovery process, having just entered the phase where
capital is shut off for development. As was the case in the real estate sector
in the early 1990's, the bottom of the cycle will be accompanied by a complete
void of capital, which creates capital appreciation opportunity for equity
investors willing to take the risks of the restructuring process and the
uncertainty regarding the timing and magnitude of recovery in fundamentals.
8. WHAT JUSTIFIES THE FUND'S SUBSTANTIAL WEIGHTINGS IN ITS TOP THREE HOLDINGS?
The Fund's strategy is to hold approximately twenty of our research
department's highest appreciation potential ideas. At quarter end, 41% of the
Fund's net assets was invested in three companies: Ventas, Reckson Services
Industries, and Alexander's. Each of these positions has intrinsic value that,
in our opinion, is substantially in excess of the current share price. In
addition, we believe that each situation has a catalyst to
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COHEN & STEERS SPECIAL EQUITY FUND, INC.
unlock value over next year. While the risk profile of these holdings exceeds
that of the average REIT, their total return potential likewise exceeds that for
REITs, thereby justifying substantial weightings.
Ventas is a nursing home REIT whose major tenant is restructuring its
balance sheet. If completed, this restructuring -- the terms of which have been
agreed to in principle -- should give Ventas strong earnings (and dividend)
power relative to its current share price, greater predictability of earnings,
and participation in the equity value of its tenant. Reckson Services Industries
recently unveiled its strategic plan to create an 'e-cooperative' of
Internet-related, business-to-business, companies whose customers are small
businesses. One of Reckson's portfolio companies, OnSite Access, which provides
broadband Internet services to office tenants, is expected to go public in early
2000. The catalyst for Alexander's stock is the development of its mixed-use
project in Manhattan -- one of the strongest real estate markets in the country,
in our opinion -- which offers meaningful value-creation potential relative to
the size of the company.
As we have mentioned, real estate security prices today are at low
valuation levels that are unprecedented. While we believe that most REITs
bottomed earlier in the year, we recognize that we cannot make that statement
with certainty; surely, recent performance is testing our conviction. What we do
feel certain about is that the REIT market is nowhere near a top. As a result,
we continue to believe that real estate securities are a far better alternative
to direct real estate, and a worthy constituent of any diversified portfolio.
Sincerely,
<TABLE>
<S> <C>
MARTIN COHEN ROBERT H. STEERS
------------ ----------------
MARTIN COHEN ROBERT H. STEERS
President Chairman
JOSEPH M. HARVEY
----------------
JOSEPH M. HARVEY
Director of Research
Cohen & Steers Capital Management, Inc.
</TABLE>
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Cohen & Steers is online at WWW.COHENANDSTEERS.COM. Visit our website for
daily NAVs, portfolio information, performance information, recent news
articles, literature and insights on the REIT market.
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COHEN & STEERS SPECIAL EQUITY FUND, INC.
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
NUMBER % OF
OF SHARES VALUE NET ASSETS
---------- ----------- ----------
<S> <C> <C> <C>
EQUITIES
*Reckson Services Industries........... 348,400 $ 5,509,075 15.37%
*Ventas................................ 1,012,400 4,808,900 13.42
*Alexander's........................... 62,200 4,497,837 12.55
**Brookfield Properties Corp............ 239,600 2,812,589 7.85
LNR Property Corp..................... 88,200 1,797,075 5.01
*Manor Care............................ 102,200 1,756,563 4.90
Mack-Cali Realty Corp................. 63,500 1,702,594 4.75
Starwood Hotels & Resorts Worldwide... 74,000 1,651,125 4.61
SL Green Realty Corp.................. 79,800 1,635,900 4.56
*Station Casinos....................... 68,400 1,590,300 4.44
*Premier Parks......................... 50,800 1,473,200 4.11
*Crescent Operating.................... 355,700 1,456,147 4.06
Mission West Properties............... 160,700 1,355,906 3.78
Vornado Realty Trust.................. 41,700 1,355,250 3.78
Apartment Investment & Management
Co. -- Class A..................... 35,300 1,350,225 3.77
Omega Healthcare Investors............ 59,400 1,247,400 3.48
*'D'Assisted Living Concepts.............. 413,200 826,400 2.31
*Genesis Health Ventures............... 331,200 786,600 2.20
*Catellus Development Corp............. 50,700 595,725 1.66
----------- ------
TOTAL EQUITIES (Identified
cost -- $43,429,010)......... 38,208,811 106.61
----------- ------
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
---------
<S> <C> <C> <C>
COMMERCIAL PAPER
Leggett & Platt Corp., 5.35%, due
10/1/99
(Identified cost -- $973,000)...... $973,000 973,000 2.71
----------- ------
TOTAL INVESTMENTS (Identified
Cost -- $44,402,010)..................... 39,181,811 109.32
LIABILITIES IN EXCESS OF OTHER ASSETS....... (3,340,983) (9.32)
----------- ------
NET ASSETS (Equivalent to $20.73 per share
based on 1,728,958 shares of capital
stock outstanding)....................... $35,840,828 100.00%
----------- ------
----------- ------
</TABLE>
- ------------------------
* Non-income producing security.
** Brookfield Properties Corp. is a Canadian company listed on the Toronto and
New York Stock Exchanges. The Toronto Stock Exchange is deemed the principal
exchange for valuation purposes. The market value of the Fund's position in
Canadian dollars on September 30, 1999 was $4,133,100 based on an exchange
rate of 0.680 Canadian dollars to 1 U.S. dollar.
'D' All exchange trading for Assisted Living Concepts ('ALF') was halted on
April 15, 1999 for, among other reasons, their failure to file timely
reports with the Securities and Exchange Commission and the American Stock
Exchange. The Fund is valuing its ALF common shares at $2.00 per share.
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COHEN & STEERS SPECIAL EQUITY FUND, INC.
FINANCIAL HIGHLIGHTS'D'
SEPTEMBER 30, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
NET ASSET VALUE
TOTAL NET ASSETS PER SHARE
--------------------------- ------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE:
Beginning of period: 12/31/98............. $ 55,159,202 $20.88
Net investment income............... $ 126,553 $ 0.06
Net realized and unrealized loss on
investments...................... (73,670) (0.14)
Distributions from net investment
income........................... (136,291) (0.07)
------
Capital stock transactions:
Sold.......................... 3,537,602
Distributions reinvested...... 97,099
Redeemed...................... (22,869,667)
------------
Net decrease in net asset value........... (19,318,374) (0.15)
------------ ------
End of period: 9/30/99.................... $ 35,840,828 $20.73
------------ ------
------------ ------
</TABLE>
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'D' Financial information included in this report has been taken from the
records of the Fund without examination by independent accountants.
AVERAGE ANNUAL TOTAL RETURNS
(PERIODS ENDED SEPTEMBER 30, 1999)
<TABLE>
<CAPTION>
ONE YEAR SINCE INCEPTION (5/8/97)
- --------- ------------------------
<S> <C>
-3.36% -2.83%
</TABLE>
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COHEN & STEERS SPECIAL EQUITY FUND, INC.
OFFICERS AND DIRECTORS
Robert H. Steers
Director and Chairman
Martin Cohen
Director and President
Gregory C. Clark
Director
George Grossman
Director
Jeffrey H. Lynford
Director
Willard H. Smith, Jr.
Director
Elizabeth O. Reagan
Vice President
Adam Derechin
Vice President and Assistant Treasurer
Lawrence B. Stoller
Assistant Secretary
KEY INFORMATION
INVESTMENT ADVISER
Cohen & Steers Capital Management, Inc.
757 Third Avenue
New York, NY 10017
(212) 832-3232
FUND SUB-ADMINISTRATOR AND TRANSFER AGENT
Chase Global Funds Services Co.
73 Tremont Street
Boston, MA 02108
(800) 437-9912
CUSTODIAN
The Chase Manhattan Bank, N.A.
One Chase Manhattan Plaza
New York, NY 10081
LEGAL COUNSEL
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, NY 10017
DISTRIBUTOR
Cohen & Steers Securities, Inc.
757 Third Avenue
New York, NY 10017
NASDAQ Symbol: CSSPX
Website: www.cohenandsteers.com
Net asset value (NAV) can be found in the daily mutual fund listings in the
financial section of most major newspapers under Cohen & Steers.
This report is authorized for delivery only to shareholders of Cohen & Steers
Special Equity Fund, Inc. unless accompanied or preceded by the delivery of a
currently effective prospectus setting forth details of the Fund. Past
performance, of course, is no guarantee of future results and your investment
may be worth more or less at the time you sell.
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COHEN & STEERS
------------------
SPECIAL EQUITY FUND
QUARTERLY REPORT
SEPTEMBER 30, 1999
COHEN & STEERS
SPECIAL EQUITY FUND
757 THIRD AVENUE
NEW YORK, NY 10017
STATEMENT OF DIFFERENCES
------------------------
The dagger symbol shall be expressed as.................................... 'D'
