InfraCap REIT Preferred ETF: A Conservative Income Vehicle To Buy On A Pullback

Summary

• PFFR is an ETF that holds a portfolio of real estate investment trust preferred stocks.
• Most of the portfolio is in equity REIT preferreds, but slightly less than 30% is in mortgage REIT preferreds.
• REITs may not be the most conservative issuers of preferred shares, but they are far from the riskiest.
• PFFR currently doesn't give the opportunistic price/yield at which I would buy, but the ETF still offers some upside and a high yield for conservative income investors.
• Looking for a helping hand in the market? Members of High Yield Landlord get exclusive ideas and guidance to navigate any climate. Learn More »

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Finding reliable income in a low yield, low interest rate environment is a difficult task.

Sure, there are plenty of stocks that yield 6%, 7%, 8%, or higher, but most Seeking Alpha readers are keenly aware that high yields are never without risk. In such a low interest rate world, the market will bid up the prices of income-generating assets until those high yields are no more.

That's what makes preferred stocks so interesting. In terms of a claim on company cash flows, preferreds are higher in seniority than common equity but lower than debt. Interest on debt must be paid first, then preferred dividends, and only then can common equity dividends be paid. They offer higher yields than common equity, but preferred dividends are fixed like interest on debt. Moreover, preferreds are not considered debt, which can make leverage ratios lower than they would be if the company had instead used debt.

But most types of companies avoid preferred equity altogether. And the ones that do use preferreds, such as banks and business development companies, often operate with high levels of debt or higher risk business models.

That's where InfraCap REIT Preferred ETF (NYSEARCA:PFFR) comes in. Since the Great Recession, real estate investment trusts have steadily become more financially conservative, deleveraging to the point where debt levels are currently near the lowest they've been in the last 20 years.

Source: NAREIT T-Tracker Q4 2020

PFFR currently offers a 6% yield, with monthly dividends that were not reduced during the COVID-19 pandemic over the last year. And the expense ratio is relatively modest at 0.45%.

Income investors could do a lot worse in this market, but personally, I am waiting for a pullback to buy PFFR at a 7% (or higher) yield.

Pandemic Performance

Almost all kinds of risk assets sold off sharply around this time in March last year. Preferred equity ETFs were no different, but some fared better than others. Unsurprisingly, the low-cost Global X U.S. Preferred ETF (PFFD) (blue line below), which counts such blue chip names as Wells Fargo (WFC), Citigroup (C), and NextEra Energy (NEE) among its top preferred holdings, experienced the smallest drawdown and quickest recovery. Meanwhile, the higher risk names in the Virtus InfraCap US Preferred Stock ETF (PFFA) caused that fund to underperform.

Data by YCharts

However, lower risk and lower volatility during market disruptions is met by corresponding dividend yields. The higher risk PFFA sports a higher yield, while the lower risk PFFD offers a lower yield, with PFFR in the middle.

Data by YCharts

As previously mentioned, PFFR holds only real estate investment trust preferred stocks, which the fund managers believe offer an attractive risk-return profile. And, as also previously mentioned, REITs tend to have lower debt levels than banks and other lending vehicles like BDCs.

Source: PFFR Q4 2020 Fact Sheet

Perusing the top ten holdings of the fund, we find such solid and defensive names as warehouse/distribution REIT Monmouth Real Estate (MNR), industrial PS Business Parks (PSB), and the mortgage REIT giant Annaly Capital (NLY).

Source: PFFR Web Page

Though a few mortgage REITs are represented in PFFR's top holdings, most of the fund's exposure is to equity or "property" REITs — the landlords rather than the lenders. Moreover, within the realm of equity REITs, PFFR spreads its exposure across almost all property types.

Source: PFFR Q4 2020 Fact Sheet

I'm pleased to find that hotel REIT preferreds do not make up a significant portion of the overall portfolio, since these property types are subject to some of the highest risk of dividend cuts during recessions and (as we recently found out) pandemics.

Bottom Line

Like all other preferred stock ETFs, PFFR is subject to selloffs during rates-driven market panics, such as the one that occurred at the end of 2018. And it is also subject to selloffs when the underlying REITs in its portfolio suffer shocks such as a pandemic or a recession.

But, overall, PFFR is one of the safest high yield income vehicles available. The ETF likely has another 3-5% of price upside from here, but I will remain on the sidelines until the next opportunistic buying occasion manifests. For me, that means waiting until the ETF offers at least a 7% yield, or a price of $20.50 per share based on the annual dividend of $1.44.

For less opportunistic and/or more conservative income investors, buying PFFR today still offers a little bit of upside plus a safe 5.9%+ yield.

Analyst’s Disclosure: I/we 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.