Although I might appear to be a risk-taker, I'm conservative by nature. Paradoxical? Not really. I never gamble with more than I can comfortably afford to lose. The true risk-taker gambles with money he cannot afford to lose. Consequently, you might have noticed that when I propose a high risk/reward investment, I almost always mention that it should be only taken by those investors able to afford the loss. This article is designed for the conservative investor, unwilling or unable to make the riskier investments.
As a class, I believe equity REIT's offer reasonably modest yields in exchange for relatively safe investments. A rather simple, yet effective way of determining this is by examining the offering prospectus and the initial yield percent at par. Riskier initial par yields of, say, 8% or more, indicates that the offering company's credit rating is not that great, therefore, to entice lenders (in our case, preferred investors) it must offer a greater return on their investment, or ROI. Those companies offering preferreds at an initial percentage below 7%, I consider relatively safe and worthy of inclusion in a conservative portfolio. An easy way of determining this is by visiting on of my favorite web sites, Quantum Online.
Notice, the link I provided, opened to Ahsford Hospitality (NYSE:AHT) and the three preferred securities it offers. Although I consider this company, presently, not the safest bet, because of my long experience with it as an investor, I am willing to take the risk for the reward that could be earned; however, I'm a risk-taker who can afford the loss if the market turns against me, others might not feel the same way, who with I most certainly cannot disagree.
Hospitality Properties Trust (NYSE:HPT) is a great example to illustrate how varying interest rates and price, over time, has demonstrated that this company's fortunes have improved to the point that it no longer has to borrow money at inflated interest rates. This is no different from a mortgage seeker. The better his credit rating, the lower the interest rate he will be charged on the loan. Lets look at Quantum's view of this company's preferred offerings.
Notice the grayed-out A, B, and C series have been called by the company and are no longer available for trading. If you were to click on the A series, you will see that it was first issued in 1999, when HPT was obviously perceived a weaker company and, at the time, forced to offer a higher 9.50% interest rate to entice investors. Today, this much stronger company, not only offered it D series initially at 7.125%, investors are willing to pay up to $26.15 to own it. That's an effective yield of 1.7825/26.15 = 6.81%, what many investors might consider a very safe bet. However, I don't because of the callable date, 1/15/17. In less than a year, HPT just might call in those preferreds, and the less than knowledgeable investor who paid that $26,15, will lose $1.15 of his investment because the call price is that of the $25.00 issue price. Regardless, the point of this exercise is that HPT is now considered a stronger, less risky, company that more conservative investors are willing to invest in. Also note that this price will fall toward its $25.00 call value within a short while as the callale date approaches.
Lexington Realty Trust (NYSE:LXP) is a large cap equity REIT, having a market cap of approximately $2.3 billion. The only uncalled remaining preferred it offers is LXP-C, issue price of $50.00, which offers a yearly dividend per share of $3.25. Its closing price as of Friday was $49.00, meaning its effective yield at that price is:
- 3.25/49 = 6.63% Yield
- An attractive fixed yield for the conservative investor, considering the size and strength of the company.
- Its dividends are paid quarterly and they are cumulative.
- They have no maturity date and can be converted to common shares only at the request of the holder, meaning the investor.
- These shares have been callable since 2009*, consequently, they can be called at any time, and I would strongly advise they never be purchased above their $50 call price.
*Notice, because an issue is callable, it doesn't mean that it will be called around the time of its call date. Quite the opposite, many preferred equities are not called for years past their call dates, which is the rule rather than the exception.
DDR Corp. (NYSE:DDR) is an equity real estate investment trust. It invests in the real estate markets of the United States and Puerto Rico. The firm is in the business of acquiring, owning, developing, redeveloping, expanding, leasing and managing shopping centers. It formerly known as Developers Diversified Realty Corp. It has a 6.33 billion dollar market cap, and since being downgraded in January, it has been trending higher. From my perspective as a preferred investor, I feel it is a relatively safe bet, meaning its potential for going bankrupt, I consider, very low.
Currently, its two remaining uncalled preferreds are DDR-J and DDR-K, each issued, respectively, at a yield of 6.50% and 6.25%, paying a yearly dividend, respectively, of $1.625 and $1.5625 per share. As of Friday, J closed at $25.98 and K at $26.00. Because each are approximately $1 above their call price, I am most interested in their respective call dates, meaning when each are callable at $25.00. J is callable 8/1/17 and K is callable 4/9/18. Personally, not my cups of tea, considering the approximate $1 loss if called, and the certain drop in price as their respective call dates approach, which for the J should be in the nearer future. Their respective effective yields at their current prices are:
- J 1.625/25.98 = 6.25%
- K 1.5625/26.00 = 6.01%
This is a good teaching opportunity. Although J offers a better yield, it is eligible to be called several months earlier, which means its price will likewise fall several months earlier. Will the increased yield be worth the more immediate drop in price? As far as I'm concerned, neither issue is worth the price, and I wouldn't consider investing in either until their prices were no higher than their $25.00 call value. Sometimes safety can be purchased at too high a price.
Similarly, for this article, I reviewed Welltower (NYSE:HCN) preferred series I & J and found both not to my investment taste for primarily the same reason I avoided investing in DDR preferreds. The I, currently priced at $62.14 is a full $12.14 above its call value of $50.00, callable 4/20/18. In my opinion an insane buy presently. The J series, presently priced at $26.25 and callable 3/7/17, although not as crazy, is still not a good buy at this $1.25 premium above its call value of $25.00.
In conclusion, I believe, for the most part large cap equity REIT's are safer investments from a preferred investor's perspective; however, the rewards are not nearly as attractive. Furthermore, investors should be aware of when they become callable, especially when they are priced above their call value, considering that the dividends earned might not cover the dollars lost should the preferred be called sooner than expected, or of the unrealized loss they will suffer as the price falls as the callable date approaches.
Disclosure: I am/we are long AHT-D, AHT-E.
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.