A Preferred Bond Replacement Strategy For Intelligent REIT Investors
By Brad Thomas
The increase in demand for preferred REIT shares is at an all-time high as many investors find the complementary fixed-income class especially attractive. This bodes well for investors as the menu for REIT alternatives helps to round out a diversified real estate portfolio.
Remember that the primary objective for preferred shares is income and therefore the intelligent REIT investor should remain focused on the fact that Preferred REIT income is equivalent to bonds (for income); however, they yield more than bonds (but with a similar risk profile). Perhaps a better way to describe preferred stocks is that they could be something like a "bond replacement" strategy.
I often recommend that investors implement a blended strategy of buying both REIT common stock and preferred stock; this way investors can take advantage of any dividend growth and stock appreciation from common stock, while enjoying higher dividend yields from preferred stock. The preferreds could add more of a complementary "bond-like" component to the fixed-income portion of your portfolio.
As explained by Larry Raiman (founder and CEO of LDR Capital Management) REIT preferred shares offer investors five characteristics:
- Attractive long term risk-adjusted returns
- High current income
- Good underlying credit quality backed by U.S. commercial real estate
- Historically low volatility as compared to equities
- Low correlation to other asset classes
Before addressing each of the above (characteristics), Raiman suggests a review of the following basic terms of REIT preferreds:
- Market listed securities with $25 par value
- Perpetual fixed and floating rate securities
- Dividends paid in cash on a quarterly basis
- New issues carry 5-year call protection
- REIT preferred securities are normally a non-voting class of ownership
- Senior in ranking to common stock but junior in ranking to debt
- Ratings for REIT preferred securities are usually lower than debt since preferred dividends do not carry the same covenant protection as interest payments from bonds.
- REIT preferred securities carry cumulative dividend covenants. A cumulative preferred stock requires that if a company fails to pay any dividend or any amount below the stated rate, it must make up for it at a later time.
- New issues incorporate typically change of control provisions.
- REIT preferred dividends are generally taxed at ordinary income rates.