REIT Preferred Stocks: Odd Duck Income Investments You Should Consider

by Ralph Block

[Note: The following essay, written some time ago, has been modified and updated for QuickReference.Info as of January 2011. Ralph Block is an expert REIT investor and author of several books on the subject.]

A couple of years ago Andrew Bary wrote an article in Barron’s about preferred stocks – specifically those issued by financial institutions, e.g., Bank of American, Citigroup and others. The essence of his article, entitled “It Only Looks Like a Wipeout,” (Barron’s, February 9, 2009), was that many banks’ preferred stocks, while not without risk, “appear to offer an attractive alternative to the banks’ common shares, owing to super-high yields and a higher standing in their capital structures.” If you are interested, you can try here.

Mr. Bary has written about REITs on occasion. But they are not his specialty, and he made no mention of REIT preferreds in his article. I, on the other hand, spend many of my waking hours – perhaps too many – on REITs and the REIT industry. Furthermore, commencing several years ago, I became a big fan of REIT preferreds. At a time when many chastened investors are looking for yield, perhaps a brief discussion of these income stocks might be of interest.

REIT common stocks have long been odd ducks. Are they equities or real estate? Are they owned for income, or for total returns? Should their investors look at GAAP net income, or supplemental measures such as “FFO,” “AFFO,” and “CAD?” How do we value them – like other equities, or on the basis of their net asset values? Are they interest-rate sensitive, or economy-sensitive?

In many ways REIT preferred stocks are even odder ducks. They are not debt obligations of a REIT, and thus are junior to REIT debt, but are senior to REIT common stock (with respect to dividends and liquidation preferences). At times their prices are interest rate-sensitive, but not at others. As there is no maturity date, unlike bonds, there is no “date certain” at which our investments must be repaid to us. They are quite illiquid, and must be bought with the care that Sammy, my Golden Retriever, uses when walking near the neighborhood pit bull. They bear high dividend yields, but have little capital appreciation potential. (continued below the link)

Many REIT preferreds today are intriguing investments, due to their substantial current dividend yields, ranging from 7% to 8%. These yields are higher than all but the junkiest of junk bonds. Some lesser quality preferred issues yield even more. There is a yield for every risk appetite. These current returns are very competitive with the total returns we should reasonably expect from REIT common shares or, indeed, from large- and small-cap equities. And they offer greater protection from deteriorating cash flows if space markets weaken again. They are also less volatile than REIT commons, making for a good investment soporific when markets are volatile.

As many REIT preferreds today trade at prices close to, and some even in excess of, their call prices (normally $25/share), we need to be aware that they may be called away from us and extinguishing our dividend streams at inopportune times. On the other hand, they also trade at healthy spreads and risk premiums over the yields on US Treasury notes and bonds; this is (continued on page 2)

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