As interest rates have been creeping higher in recent weeks, investors have been running scared from some of the equity-like investments meant to serve as “bond substitutes.” Among both mortgage and equity REITs, there are numerous examples of the-Fed-might-taper hysteria causing a large selloff in a security.
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One of the things I find most disconcerting about never-ending QE is that after several years of virtually non-stop money printing by the Fed, the financial markets have become addicted to it. This results in valuations that are higher than they otherwise would be absent the market-wide expectation that the Fed will not allow asset prices to fall. In turn, it is impossible to know how to accurately value a security for a world without QE. So when the Fed one day begins to taper QE, stop QE, sell assets, or raise interest rates, equity prices (among other asset prices) could fall much further than many investors may expect. Without QE, I am confident market-wide valuations would be much lower. How low is anyone’s guess. But in terms of predicting direction, the direction is lower. With this in mind, despite being tempted to purchase the common stock of various REITs on the most recent pullback, I’ve instead turned to the preferred stock in search of long-term income-producing assets.
The preferred stocks of many REITs, like the common stocks, have recently sold off. As the selloff intensified, I decided to do some shopping. In this article, I would like to introduce readers to two of the preferreds I purchased and the businesses backing those preferreds.
Regency Centers is a REIT that concentrates on creating grocery-focused shopping centers for some of the best known grocery businesses in the country. Approximately 85% of its portfolio is grocery-anchored, and its 345 properties include tenants such as Safeway, Kroger, Publix, and Whole Foods. In terms of location, Regency Centers has 24 target markets, the top 12 of which make up slightly more than 75% of net operating income (NOI). Current 2013 guidance for percent of properties leased stands at 94% to 95%. Among the largest centers (greater than 20,000 square feet), however, leased space is running over 99%. There is certainly more information to research as part of your due diligence, and I encourage all readers to spend more time looking into this REIT’s business prospects before making an investment.
If Regency Centers does pique your interest, and you decide an investment is appropriate, the 6.00% Series 7 Cumulative Redeemable Preferred Stock (REG PG) may be of interest. Recently trading at $24.25 and yielding 6.19%, this preferred stock pays a $1.50 annual dividend in quarterly installments on March 31, June 30, September 30, and December 31 of each year. Dividends are cumulative.
Additionally, there is no maturity date for the Series 7 preferred stock, and on and after August 23, 2017, shares are callable at Regency Centers’ discretion at $25 per share. Moreover, upon a change of control, there is a conditional right to convert shares to common stock as well as a “Special Optional Redemption” at $25 per share plus accrued but unpaid dividends.
Digital Realty is a data center REIT with 123 properties in 10 countries throughout North America, Europe, Asia, and Australia. It has more than 600 tenants and roughly 2,000 leases across its 23.1 million square feet of rentable space. Although Digital Realty’s properties are located around the world, it should be noted that approximately 80% of its rent comes from properties in North America. Among others, its tenants include CenturyLink, Morgan Stanley, Facebook, AT&T, and Verizon. Digital Realty’s occupancy rate is currently 93.1% with the average remaining lease term at 6.9 years.
It is also important to point out that Digital Realty’s common stock has short interest in excess of 20%. While there are investors who see such short interest as a positive due to the prospects of a short squeeze, when I see such high short interest, it gives me pause. With that said, I was still comfortable purchasing the 5.875% Series G Cumulative Redeemable Preferred Stock (DLR PG). Recently trading at $22.88 and yielding 6.42%, this preferred stock pays a $1.46875 annual dividend in quarterly installments on or around the last day of March, June, September, and December of each year.
Dividends are cumulative. Additionally, there is no maturity date for the Series G preferred stock, and on and after April 9, 2018, shares are callable at Digital Realty’s discretion at $25 per share. Moreover, upon a change of control, there is a conditional right to convert shares to common stock as well as a “Special Optional Redemption” at $25 per share plus accrued but unpaid dividends. As I mentioned concerning Regency Centers, there is certainly more information to research as part of your due diligence, and I encourage all readers to spend more time looking into Digital Realty’s business prospects before making an investment.
In closing, let me address a few questions you may have:
1. Are the dividends paid by these preferreds considered “qualified dividend income” for tax purposes?
It is my understanding that the dividends of the preferred stocks mentioned in this article are not considered “qualified dividend income” for tax purposes. If you decide to purchase either of the preferreds, spend some time considering the merits of owning REIT preferreds in a tax-advantaged account (such as an IRA).
2. Why didn’t I choose one of the higher-yielding Regency Centers or Digital Realty preferreds?
While Regency Centers’ 6.625% Series 6 preferred stock and Digital Realty’s 6.625% Series F and 7.00% Series E preferred stocks may be more enticing to some investors, I am hoping to hold onto my preferreds well beyond the dates on which they become callable. I therefore decided to go with the lowest coupons available because, in my opinion, the coupons were still quite respectable while affording me a better opportunity than the other preferreds would to avoid having my shares called. If the interest rate environment one day changes such that a new higher range for benchmark Treasury rates appears to be in our future, I would consider further adding to my exposure in Regency Centers and Digital Realty through the other preferreds.
3. Aren’t these relatively illiquid securities?
Yes, these are relatively illiquid securities. I would encourage investors to stick with position sizes that are in the hundreds of shares rather than thousands of shares. Also, keep in mind that just because there are wide bid-ask spreads does not mean you must accept the offer price. On June 13, I placed an order to purchase Regency Centers’ Series 7 preferred stock at the bid, and I was eventually filled. Regarding illiquid securities, I’ve had surprising success over the years getting buy orders filled at the bid price. Intuitively, it can make sense that I would have such success in illiquid securities. If someone else wants out of his or her position, that person needs to find a buyer. If you are willing to buy and let your intentions be shown to the market via a buy order placed at the bid, a willing seller may see that new liquidity and jump at the opportunity to get out.
4. Should I be concerned about the fact that there is no maturity date?
As someone who is content with timeless exposure to the preferred stocks of various REITs and as someone who manages personal liquidity in a way that ensures these REIT preferreds would not need to be sold at an inopportune time, I am not concerned by the perpetual nature of the securities. Your situation may be different, and I certainly understand why the lack of a maturity date would cause some investors to shy away from these preferred stocks.
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