With income investors no strangers to real estate companies, many flock to companies such as LaSalle Hotel Properties (LHO) in the search for yield. And while LHO pays a decent dividend, currently 3.6%, it has inherent stock market risk associated with owning any common stock and others, including dilution. For an income investor, those things can inhibit capital preservation and dividend growth and in short, you can do better. In this article, we'll take a look at the Series H Cumulative Redeemable Preferred Shares (LHO-H, may differ depending on your broker) to see if it is a fit for your income portfolio.
LHO-H is a pretty straightforward issue but we'll start by defining it. LHO-H is a traditional preferred stock, meaning it has no stated maturity date and no debt issue backing it, as is the case with a trust preferred stock. The 7.5% coupon, or $1.875 annually, on the preferred is paid in quarterly installments. And the issue price of $25 makes it within the reach of all investors, unlike some preferreds that are issued in lots of $1,000 or more.
Although LHO-H was issued at $25, it is now trading for a small discount to that price at $24.60 as of this writing. That means that if you were to purchase at that price, your current yield would be a robust 7.6%, slightly higher than the stated coupon on LHO-H. In addition to that, you are given a bit of capital gains cushion on the issue and while it isn't much, buying preferreds at a discount to the issue price is always a good idea.
Beginning in January of 2016, LHO can call LHO-H at its option at the full $25 issue price. This means that by buying LHO-H, you may be called away in only two years and while that wouldn't be ideal for those wanting long term income, it wouldn't be a disaster either. Since LHO-H is trading at a discount you'd be entitled to your entire investment of $24.60 plus the 40 cents of discount, meaning you would see a small capital gain should the issue be called. No one can accurately handicap if this will happen or not, except LHO management, perhaps, but with rates looking like they're headed north in the medium term I would suggest LHO-H, in my view, is an unlikely candidate to be called at that time. Even if it did, the worst that would happen is that you're made whole plus a small premium.
In addition to this, even though LHO-H is a traditional preferred stock and pays dividends instead of interest, since it is issued by a REIT it is unfortunately not eligible for the favorable dividend tax treatment. For a holder in a retirement account it wouldn't matter but anyone holding LHO-H in a taxable account will see a significantly lower after-tax yield versus a comparable issue that is eligible for the favorable tax treatment. Thus, depending on your situation, LHO-H may not be right for you.
Finally, as LHO-H has no stated maturity date, it is subject to interest rate risk. If interest rates spike we could see LHO-H fall in price in order to meet rising yields on other securities. This could leave investors with capital losses but that is the risk you take in owning a preferred security. You must decide for yourself if the risk of interest rates rising significantly would eat into your capital and if that is not a risk you can take, preferred securities are probably not for you. Of course, if interest rates move down again, LHO-H will likely increase in price. The point is that you must do your own due diligence on LHO-H or any other income investment in the context of interest rates before taking a position. LHO-H is a terrific example of a high yield preferred stock from a quality issuer but it is still risky and the current yield reflects that.
Overall, LHO-H offers investors a very high current yield from an issuer that I believe to have very little repayment risk (see my article linked above for a discussion of LHO's business). Even in the event that LHO were to miss dividend payments, LHO-H is a cumulative issue, meaning that LHO would be obligated to make up the missed payments. Thus, barring bankruptcy, which is beyond a remote possibility in my view, your dividends are guaranteed. In addition, LHO's financial strength is an asset to those wanting income as I believe LHO-H is undervalued in the current environment. As long as you can move past the unfavorable taxation treatment of LHO-H, it could be a great addition to your income portfolio and an issue you could collect a large current yield from for years to come.
Additional disclosure: I may initiate a position in LHO-H at any time.