Is REIT Preferred Redemption In Your Future?

by: Rubicon Associates


I have identified eighteen REIT preferred stocks that have passed, or soon reach, their optional redemption date.

An estimation of which of the eighteen is most at risk is provided.

While rates are higher, investors have to be aware of the call risk and implications.

Preferred redemptions. Many folks laugh when they hear this as rates have been increasing and the likelihood of preferreds being redeemed has fallen. There is truth to this, but absolute truth is hard to come by and absolute truth in the market is a pipe dream.

While many may think that there is no reason to look at the early redemption option due to the increase in rates, I tend to disagree.

Consider the following chart:

Despite all the wringing of hands and gnashing of teeth, rates are not in uncharted territory. Over the last few years, I rarely heard investors dismiss the possibility of early redemption of their preferred stock.

That said, in the chart above, I have blocked off that area roughly five years ago that preferred stocks that are currently redeemable would have been issued. Note that rates were lower at that time. This helps reduce the redemption potential, but not eliminate it.

To this end, I have put together a table that lists preferred stocks that have passed, or will soon pass, their optional redemption date. Where possible, I have included other preferred stocks of the issuer in order to determine what the market clearing yield might be for that issuer. I then subtracted the market clearing level from the stripped yield of the callable issue in order to come up with the potential savings (in basis points). For purposes of this note, I have bolded those issues with potential savings over 75 basis points. I have used 75 basis points as the level at which it is economic for the issuer to redeem the issue. As I am not a banker, this is not exact, but it might help frame investor expectations.

It must be noted that there are issues/limitations with using existing series of preferred stocks to determine the market clearing yield. The largest issue is that many of the existing preferred stocks are approaching their optional redemption date. The optional redemption is, essentially, a call option you have written to the issuer and therefore has value. As with all options there is a time value, and a five-year option is worth more than a five-month option; therefore, the market clearing yield should be below the yield of a preferred with a near-term call option.

The following is a summary of those preferreds that are past, or soon to hit, their optional redemption date, in tabular and graphical form.

Two that I believe are most at risk are the Vornado (NYSE:VNO) Series G and I preferred as they both have potential savings of nearly ninety basis points and the issuer would be well received by the market.

Ultimately, investors cannot just overlook the optional redemption date and should - however improbable it may seem - take note of the effect on returns.

Disclosure: I am/we are long NLY.

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.