The ABCs of REIT Preferred Stocks

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about the original offering price or par value?  Well, it tells you what the stock was once thought to be worth, and it is probably equal to its call value.  The call value is a lot more important to you than the par value, since you care about the future more than the past.   A “call” is when the company calls in the shares and pays a dollar amount, the call value or call price,  for them.  The company has the power to call the shares after a certain date (the “call date”)   but not the obligation to do so.    Preferred stock generally can go on forever if the company wants them to (and if the company survives) and that is what is meant by “perpetual preferred.”   Not that they will go on forever — just that they will if the company allows them to.  Contrast this to a bond:    A bond has a maturity date, when the company is obligated to pay off  the bond’s face value.  A preferred stock has nothing like a maturity date.  You can sell it at any time, but the price cannot be predicted with certainty and the company that issued it cannot be forced to buy it.

 The call is optional for the company; but if one occurs, it is mandatory for the shareholder.  You cannot opt to continue to hold your shares if they are called.

If a preferred stock is trading above its call price, then you should evaluate the risk of a call.    Let’s say a preferred is selling at 26 and has a call price of 25.   If the company calls the stock, the market value will immediately fall to 25 and when your shares are redeemed by the company, or when you sell them, you will only get $25 per share.  So that $1 of premium over the call price (26 minus 25) represents a dollar of call risk.   Usually, preferred stocks will not sell much above their call price unless the potential call date is pretty far away.   But, this is not always true; so be careful about buying a preferred for more than its call price and consider selling any that you hold that rise above their call price.   I say “consider” because if the dividend is fat and safe, you might reasonably choose to risk a modest loss on the share price due to call risk in order to collect the dividend until it is called.

Sometimes there are several call prices, tied to several dates.   A preferred might be callable at $25.50 on January 15, 2015 and thereafter and at $25 starting on January 15, 2016, for example.   This just means the company would have to pay an extra 50 cents a share if it called the stock between those 2 dates rather than waiting until after the latter date.

For preferred stocks selling above their call price, analysts calculate something called “yield to call.”   This is your total average annual return based on today’s market price as the starting point, the call price as the ending point, and the dividend stream scheduled to be paid in between.  So this calculation takes into account the dividend income and the capital loss due to the call and rolls it into one number, expressed as an average annual total return percentage.    The yield to call will be less than the current yield in such instances, because of the capital loss that is anticipated.  The yield-to-call calculation assumes there will be a call on the call date, which may not in fact be the case.    If, the company does not call the stock and continues to pay the dividend, and the stock price remains above the call price, your actual return will be greater than that predicted by the yield-to-call calculation.

Sometimes you see this calculation termed “yield to first call.”   The “first” indicates that there are several call dates corresponding to several different call prices and this calculation is based on a presumed call  at the first call date.

Sometimes naive investors  look at yield to call on stocks selling below their call price, as if the company might call the preferred and pay the call price even though the stock sells for less than the call price in the open market.   Theoretically this could happen, but in practice, it almost certainly won’t.  Generally, if the stock is selling below the call price, the company is content to leave it outstanding.  If market conditions are such that the stock cannot command par value in the open market, then chances are very good that the company cannot obtain new financing on sufficiently favorable terms to make it attractive to retire the issue.   Moreover, if the company did want to get the stock back, it could buy the shares in the open market more cheaply than calling them. We have seen this happen:  Some companies bought in preferred shares during the aftermath of the 2008 financial crisis, when they were very cheap.    So, yield-to-call is not meaningful for stocks selling below their call prices.   If you buy or hold a preferred priced below the call price, don’t pin your hopes on getting a sudden capital gain from the company calling the shares.  It’s very unlikely.

Generally a call is bad news for the stockholder.  Not real bad news, but semi-bad.   Presumably, if you receive a call, you were holding the stock and happy to do so.   If you weren’t happy to hold it, you would have sold.   Often, the market price the day before the call is at least a little higher than it is and will be after the call is announced.    After the call and the redemption of your shares, you have the problem of re-investing your proceeds.   Generally, it will be difficult to find a preferred stock to buy with characteristics as good as the one that got called away, in terms of the risk/reward combination offered.   The difference may be slight, but it just stands to reason that if calling was a good deal for the company, it was a bad deal for the stockholder.  

Why would a company do something bad for its stockholders?  Well, as a preferred stockholder, you are not one of the stockholders that management is hired to look out for.   They work for the common stockholders.   You are more like a lender — an arms-length provider of capital, not a co-owner.   It is management’s obligation to raised capital from lenders and preferred stockholders as cheaply as possible.    If the terms they are giving you as a preferred stockholder are better than they would have to give to attract investors to a new issue of preferred stock, then they will pay you off and replace your (continued)

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