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Northstar Realty Finance (NRF) is a commercial REIT that operates in the US investing in various real estate assets including collateralized debt. The company is a big issuer of preferred securities as a source of financing and in this article, we'll take a look at the Series A Cumulative Redeemable Preferred Stock (NRF-A) to see if it could be a good fit for your portfolio.

NRF-A is a traditional preferred stock, which means it has no stated maturity date and also has no debt issue backing it. However, NRF-A does have the very nice feature of being cumulative, which essentially means that if NRF were to miss dividend payments it is obligated to make them up to holders of NRF-A. This is a sizable positive as it means that barring bankruptcy, your dividends are basically guaranteed as they cannot be thrown out by NRF in a liquidity crunch.

As the title of the security suggests, NRF-A is also redeemable. Since 2011, NRF has had the option to call this security and has chosen not to. However, if NRF does decide to call the security, holders will be entitled to receive the full $25 per share call price (the same as the issue price) in exchange for their shares. As shares are trading just over $24 as of this writing, that means that if a long position were initiated today and NRF-A was called, holders would be entitled to a roughly 5% capital gain. While this isn't much, it is a bit of a cushion against capital losses and ensures that if NRF-A is indeed called at some point, it won't be at a capital loss to those who buy at a discount.

The Series A pays a $2.1875 annualized dividend in quarterly installments, good for a coupon yield of 8.75%. But, as I just said, shares are trading somewhat lower than that right now so the current yield is actually somewhat higher at 9.1%. That is a terrific yield and is in the upper echelon of traditional preferred yields at the moment.

Unfortunately, even though NRF-A pays dividends and not interest payments, since it is issued by a REIT it is ineligible for the favorable dividend tax treatment. To a holder in a retirement account, this shouldn't matter but for a holder in a taxable account, this can seriously erode the after-tax return of NRF-A. Everyone's tax situation is different so if you're looking to hold NRF-A in a taxable account make sure you understand the tax implications of doing so.

Understand also that holding any income producing security is going to come with some interest rate risk. As NRF-A is a perpetual security it too will suffer from this affliction. If, for instance, we see interest rates spike we may see preferreds trade down as a group to meet the new expectation of higher interest rates. If this happens holders of NRF-A will likely be subjected to capital losses and potentially significant ones at that. Of course, if interest rates move down again NRF-A will likely trade up in that situation. The point is that you must be comfortable with NRF-A moving around because it will, particularly if you're a long-term holder. If you intend to hold NRF-A for many years you must feel comfortable with the likelihood that you'll see paper capital losses at some point. But if you are called away, at least know that you'll be made whole at $25 per share so you won't be forced to sell at a loss.

I think the market has undervalued NRF-A given the issuer's strength and ability to fund this preferred. If you can stomach the potential price changes due to interest rate movements you've got the opportunity to own a good quality preferred that is cumulative and pays over 9% at current prices. NRF-A is being priced as though interest rates have already moved up significantly and as the move has been muted in my view, NRF-A represents an opportunity. The unfavorable tax treatment of the dividends is a negative for those holding in a taxable account but NRF-A is a preferred I believe you can own for many years to come and enjoy those large distributions that are currently available for a moderate discount.

Source: A 9.1% Yield On Sale For A Discount

Additional disclosure: I am long NRF-A