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SL Green (NYSE:SLG) is a very successful REIT based in New York that develops, leases and manages properties in the US. The common stock has had a very nice run over the past year, although somewhat lagging the broader market. But for income investors, the common stock's 2.2% yield is likely not enough to entice someone to own SLG. However, you can still generate large amounts of income while gaining exposure to SLG through its Series I Cumulative Redeemable Preferred Stock (SLG-I, may differ depending on your broker). In this article, we'll take a look at SLG-I to see if it is a good fit for your income portfolio.

SLG-I is a traditional preferred stock, meaning it has no stated maturity date and isn't backed by any kind of debt issue. Issued at $25 per share, SLG-I pays annualized dividends of $1.625 in quarterly installments, good for a coupon yield of 6.5%. While this is three times the common stock's yield, SLG-I is actually trading for a sizable discount to its issue price as of this writing. At $21.98, SLG-I has a current yield of 7.4%, a significant step up from the coupon on this particular issue.

In addition to the bump in current yield that arises from the discount to par, holders of SLG-I could potentially see some capital gains if the issue is called. Beginning in 2017 SLG can call SLG-I at its option for the full $25 issue price. Thus, if holders are called away, not only will they receive any accrued and unpaid dividends, but $3+ per share worth of capital gains would accrue as well. Under that scenario holders would receive nearly two years' worth of dividends in capital gains, assuming the purchase price was around $22. While getting called away from an income security is generally undesirable, when the payoff is that large, exceptions can be made.

SLG-I is also a cumulative security, meaning that if SLG were to miss a dividend payment, it would be obligated to make up that payment to holders of SLG-I. As a result, distributions from SLG-I are virtually guaranteed barring bankruptcy by SLG. Many preferred issues are non-cumulative, offering holders no safety net if the issuer runs into financial trouble. While SLG-I would certainly trade down on any news SLG was in trouble, the dividends are as safe as they possibly can be and that is a huge positive for this preferred issue.

Unfortunately, since this preferred was issued by a REIT, it is not eligible for the preferential dividend tax treatment. This is potentially a very large negative for someone holding SLG-I in a taxable account as the difference in after-tax return between a hypothetical 15% tax rate and 30% tax rate on SLG-I is roughly 110 basis points. That is a sizable amount of income to be losing to taxes and if you are planning on holding SLG-I in a taxable account, make sure you understand the implications of doing so. Everyone's tax situation is unique and that is something you must decide for yourself. Of course, if you hold SLG-I in a retirement account it doesn't matter.

The principal risk in owning SLG-I is interest rate risk, given that I don't see repayment risk as a credible threat with SL Green. As we've seen with income securities since last spring when the Fed began its taper talk, income securities can get crushed if market participants think interest rates are moving up. If that were to happen, it is not unthinkable to see SLG-I below $20 as a result. In owning SLG-I you must be okay with capital losses and gains when interest rates move up and down over the course of time as it is undoubtedly going to happen. If this is something you cannot stomach, SLG-I likely isn't right for you. However, if you can or if you are planning to hold through the volatility, SLG-I is a great choice for current income from a quality payer.

On balance, SLG-I offers what I believe to be a mispricing of risk. SLG has shown itself to be a competent, profitable operator and with the common stock trading at a premium of only 35% to tangible book value, I find it to be a safe payer as well backed by real assets. With SLG-I, I think you've got a preferred that has been thrown out with other, less desirable issues and as such, if you are holding SLG-I in a taxable account, you have a chance to do very well. Keep in mind that interest rate risk could send the price of SLG-I up and down but if you are holding in a retirement account, those fluctuations could represent nothing more than buying opportunities.

Source: A 7.4% Yield And 13% Upside From SL Green

Additional disclosure: I may initiate a position in SLG-I at any time.