New REIT Preferred Stock Prospectus Language Protects Preferred Stock Investors

Includes: DLR, HCN, HPT, KIM, NNN, REG
by: Doug K. Le Du

Real Estate Investment Trusts (REITs) started including what has become a standard provision in their preferred stock prospectuses a little over a year ago. The new provision is a risk-lowering provision for preferred stock investors. But ironically, many of those who read it can easily misinterpret the new language as increasing their investment risk.

The new provision, usually prominently displayed within the first few pages, goes on at some length describing what will happen to shareholders in the event that there is a change of control of the company.

Many readers incorrectly assume that the company is trying to tell them, without actually telling them, that the company is looking to sell and that there may be a commensurate increase in risk to anyone considering buying the shares.

Companies are including the new provision to calm the fears of preferred stock investors but, without knowing the background, many prospective shareholders are scared off by the new language. As you'll see by the example below, the new language is actually not intended for investors, but, rather, as a warning to those intending on raiding the company's assets.

Where Did This Language Come From?

Here is a highly summarized version of the obscure 2007 event in Texas that led to the new language now being seen in most of the prospectuses of REIT-issued preferred stocks[1].

Walden Residential Properties was a small, very weak but publicly traded Texas company on the verge of bankruptcy. To generate cash, the company had issued a bunch of debt (junk bonds) and speculative grade preferred stock.

In 2007, Olympus (a hedge fund) worked out a purchase deal that would result in Walden becoming delisted from the stock exchange. And all of Walden's assets (properties) would be owned by a new, but not publicly traded, company that Olympus would form.

The problem was that Olympus did not want to inherit the mountain of debt and preferred stock dividend obligations; their proposal was to just buy Walden's assets and leave the debt and preferred stock in the old company. With no revenue source, the old company's bonds and preferred stocks would become worthless and the old company would be delisted. The new company, privately held of course, would thereby be left with the assets (the properties) and no pesky bond or preferred stock shareholders whining about those overdue payments.

Walden's lawyers incorrectly advised Walden's desperate board of directors that their fiduciary responsibility to protect shareholders only included common shareholder equity, not shareholders of preferred stock equity. So Walden's board, rather than face bankruptcy, accepted the Olympus proposal.

This tactic of raiding a weak publicly traded REIT and moving the ownership of its properties into an out-of-reach, privately held company became referred to as "Waldenization."

Then: Nothing To Prevent "Waldenization"

While very few individual preferred stock investors noticed the Walden case, large institutional investors certainly did. And they got nervous. After all, what prevents a company like Olympus from swooping in and acquiring all of the publicly traded company's assets (only), putting those assets into a new private company where no one could get to them and leaving shareholders holding just the obligations with no source of revenue?

In the case of a desperate but publicly traded property REIT that owns lots of physical assets, there was certainly no binding language in the prospectuses of the company's securities that would prevent it. And that's what Olympus took advantage of.

Or at least thought they had. In the end, Walden's preferred stock shareholders sued and won. Unfortunately, by that time their victory got them little more than a polite smile from the defendants.

Now: Anti-Waldenization

To address the concerns of preferred stock investors that the Walden scenario might happen to them, REITs have started putting "Anti-Waldenization" language into their preferred stock prospectuses.

This new language allows the issuing company to redeem all outstanding preferred stock shares at par in the event of a change of control, leaving substantially less cash or other assets for a prospective raider.

We are also seeing Anti-Waldenization provisions that give the company's preferred shareholders the option not just to convert their preferred shares to the company's common stock, but do so at a very generous price that is specified in the prospectus.

A conversion of quiet non-voting preferred stock shareholders into a massive block of annoyed common shareholders with voting rights would not be welcomed by those intending on gutting the company.

Example of Anti-Waldenization Change Of Control Language

Reading prospectus language is never easy but here is an example that I have shortened to make it more readable here. This new Anti-Waldenization change of control language is from the Series D preferred stock issued by National Retail Properties (NNN) on February 17, 2012[2].

National Retail makes two specific threats right on page 1 of the prospectus. With these two threats, National Retail is speaking directly to those considering raiding the company for its assets while letting you, the preferred stock investor, listen in.

#1 - Threat to redeem at $25 if there is a change of control: "Upon the occurrence of a Change of Control...we may, at our option, redeem the Series D Preferred Stock...within 120 days after the first date on which such Change of Control occurred, by paying...$25.00 per [preferred stock share] any accrued and unpaid dividends..."

#2 - Threat to convert preferred stock shares to common if there is a change of control that results in the delisting of the company: "Upon the occurrence of a Change of Control, as a result of which neither our common stock nor the common securities of the acquiring or surviving listed on the NYSE, the NYSE Amex or NASDAQ...each holder of [preferred stock] shares...will have the convert some or all of the Series D Preferred Stock...into a number of shares of our common stock..."

Initially, just smaller, weaker (nervous) publicly traded REITs were including these types of threats in their preferred stock prospectuses. But over the last several months these provisions are now being included by bigger companies that issue some of the highest quality[3] preferred stocks available. Just this year, new high quality preferred stocks issued by Healthcare REIT (HCN), Kimco Realty (KIM), Hospitality Properties (HPT), Regency Centers (REG) and Digital Realty (DLR) have all included Anti-Waldenization language in their prospectuses.

Benefit, Not Risk

By including the new Anti-Waldenization provisions, companies are telling preferred stock investors that shareholders will be protected against the tactics of the 2007 takeover of Walden Residential Properties by Olympus.

The new change of control provisions are being included in almost all new REIT-issued preferred stock prospectuses. The next time you see language in a preferred stock prospectus that goes on and on about what will happen in the event of a change of control, especially a change of control that results in the delisting of the company, know that the issuing company is trying to erect a protective wall around you and your shares.

The new change of control provisions lower investor risk and should be seen as a welcomed effort on the part of the issuing company to help protect your investment.


[1] For a more detailed version of these events see "REIT Cash Is King" by Simon Wadsworth.

[2] The entire change of control text from this preferred stock can be read on page 1 of its prospectus on file at the SEC.

[3] High quality preferred stocks are those that meet the ten risk-lowering selection criteria from chapter 7 of my book, Preferred Stock Investing. For example, high quality preferred stocks offer "cumulative" dividends (if the issuing company skips a dividend payment to you they still owe you the money; their obligation to you accumulates) and are rated as investment grade. For more about selecting, buying and selling the highest quality REIT-issued preferred stocks read my Seeking Alpha article titled "REIT Preferreds: An Attractive Alternative To Big Bank TRUPS In 2012"

Disclosure: I am long on several preferred stock issues from REG, NNN, HPT and KIM.

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