Northstar Realty Finance (NYSE:NRF) is a commercial REIT that operates in US investing in various real estate assets including collateralized debt. In this article we'll take a look at one of its many ventures into the capital markets, the Series B Cumulative Redeemable Preferred Stock (NRF-B, may differ depending on your broker), to see if it could be a good fit for your income portfolio.
NRF-B is a traditional preferred stock, meaning it has no stated maturity date and no debt issue backing it. In addition, it pays regular quarterly distributions to its holders. Issued at $25, the annualized distributions of $2.0625 work out to a coupon yield of 8.25%. This is a very strong yield of course but with shares trading at a nearly $2 discount to their issue price, the current yield is actually appreciably higher at 8.95%. Among preferreds that are from issuers not in some sort of financial trouble, that is in the top echelon of yields.
The discount also means that if NRF-B were to be called, as it can be at any time by NRF, holders would receive not only all accrued but unpaid dividends, but also the full $25 per share call price. This means holders who get long at $23 would be entitled to receive a $2 capital gain per share on their position, further boosting potential upside on NRF-B.
In addition to the discount and huge yield, NRF-B is a cumulative issue, meaning that if NRF were to miss dividend payments to holders of NRF-B it is under a strict obligation to make the payments up. Unlike non-cumulative issues, on which payments can be missed with no explicit penalty to the issuer, distributions on NRF-B are virtually guaranteed barring a bankruptcy event as any missed dividends continue to accrue and must be paid. For a serial capital issuer like NRF missing a dividend payment is an unthinkable event as NRF needs the capital markets to function. Thus, although NRF is in a risky business, I don't see repayment risk as a bigger negative with NRF than I would with a larger REIT that is perceived to have more stability. NRF has shown a propensity to raise capital when needed and I believe this is likely to continue, lessening repayment risk on existing issues like NRF-B. However, this is something you must make peace with before initiating a position in NRF-B.
Unfortunately, NRF-B, although paying dividends and not interest, is not eligible for the preferential dividend tax treatment. Since it is issued by a REIT, this traditional preferred stock's distributions are treated as income and not dividends, thus lowering the after-tax yield of the issue for holders in a taxable account. The difference in after-tax yields in a hypothetical example of 15% and 30% tax rates is 135 basis points, a significant price to pay in after-tax yield. Of course, everyone's tax situation is unique and this is something you'll need to fully understand the implications of for your situation if you plan on getting long NRF-B in a taxable account. Of course, for those holding NRF-B in a retirement account it doesn't matter at all.
The principal risk in holding NRF-B is that of interest rate risk. As NRF-B is a perpetual security it is going to suffer from interest rate risk more than a debt issue that matures in the next couple of years, for example. It is my belief the call provision that has already come into effect for NRF-B, as it has been active for nearly two years now, will somewhat limit this due to the idea NRF-B could be called for $25 at any time. However, no one can be sure if NRF-B will be called or not so hoping for a call is not an investing strategy. Also keep in mind that interest rate risk will be higher with NRF-B than other preferreds because NRF's business model relies so heavily on interest rates in the first place. Thus, if rates spike we could see NRF-B trade down on perceived weakening ability to pay the dividends. The point is that NRF-B is not what I would consider a "safe" security to own (thus the ~9% yield) and you must be comfortable with that before owning it.
Overall, for those investors looking for a boost to their income or retirement portfolio yields, NRF-B could be a solid choice. The company has a good looking balance sheet and is cash flow positive (mainly due to capital issues such as this one), offering investors a chance to own a security that pays a great yield for a good price. If you can stomach the potential volatility of NRF-B from interest rate swings, it could be a jolt of income for your portfolio with its prodigious yield and discount to the call price. But please, if you are going to get long NRF-B, make sure you understand the risks and keep the position as a small piece of your portfolio.
Additional disclosure: I may initiate a position in NRF-B at any time.