Income investors have long been drawn to REITs for their income potential. And while that is rightly the case with the common stocks, many investors overlook preferred shares as a way to generate income. However, many REITs have terrific preferred share issues that sport very high yields and less volatility than their common stock counterparts. In this article, we'll take a look at an issue from Arbor Realty Trust (NYSE:ABR) to see if it is right for your income portfolio.
The issue in question is actually Arbor's brand new preferred stock, the Series C Cumulative Redeemable Preferred Stock. The symbol for this issue is currently ABRRP but will change to ABR-C once it is listed on the NYSE, which should happen in the next couple of weeks. As such, I'll refer to it as ABR-C henceforth.
So what is ABR-C? It is a traditional preferred stock, meaning that it has no stated maturity date and no debt issue backing it. It also pays regular quarterly dividends as you would expect a traditional preferred stock to do. Issued just over a week ago at $25 per share, the quarterly distributions of 53.125 cents per share make the coupon yield a whopping 8.5% on ABR-C. This is a very strong yield and is about 100 basis points higher than the common stock at this point. Given that ABR-C should experience less volatility than the common, it may be a better option for income investors.
Another reason why I think it may be a better option than the common is that ABR-C is cumulative. This means that even if ABR misses dividend payments on ABR-C, it is obligated to make them up. As the common stock has no such guarantee, I consider ABR-C to be a safer choice for income than the common given its higher yield and cumulative nature of distributions. Basically, barring bankruptcy, holders of ABR-C have their dividends guaranteed; no common stock offers any such guarantees. If ABR faces some financial difficulties it will likely cut its common dividend; ABR-C doesn't allow for that as ABR must continue to make payments regardless.
ABR does have the option to redeem ABR-C beginning five years from now in February 2019. At that point, ABR can redeem ABR-C for the full $25 issue price and if that occurs, holders will either have a capital gain or loss depending upon where shares trade prior to the redemption. The only reason this would happen is if ABR thinks it can reissue some form of financing, be it debt, equity or another preferred, at a lower cost. With rates still hovering near record lows, that seems unlikely. However, it could happen and it is something you should be aware of.
In addition, since this issue is new, volumes are likely to be on the low side for a while. Also given that ABR is a relatively small issuer, you'll want to make sure you use limit orders and if you are building a large position, that you do it gradually. The bid/ask spread may be decently sized until ABR-C begins trading on the NYSE so just be careful if you can't wait.
One final note on ABR-C is that although it is a traditional preferred, since it was issued by a REIT, it is unfortunately not eligible for the preferential dividend tax treatment that would otherwise be afforded. This means that distributions will be taxed as unqualified dividends and for certain investors, that could mean a materially lower after-tax yield than if it were eligible for the favorable tax treatment. This can be a substantial negative for some investors but if you hold ABR-C in a retirement account, that negative is mitigated entirely. Thus, given the tax status, I'd suggest holding ABR-C in a retirement account unless your tax situation affords you a low rate even on ordinary income.
ABR-C offers investors a chance to get in on a new preferred from a stable issuer, paying a very nice dividend. Although the dividend isn't eligible for the preferential tax treatment, the high coupon and five years until the first possible redemption date make it attractive in my view. Couple this with the fact that it should be less volatile than the common while still making higher payouts and you've got a recipe for a solid, relatively safe high-yield preferred issue.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may initiate a position in ABR-C once it begins trading on the NYSE.