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Sold APTS To Purchase MRG.UN

|About: Preferred Apartment Communities, Inc. (APTS)
Summary

APTS is one of my favorite's in the sector, but they become more risky the lower bond prices fall and yields increase.

Although they are using a strategy I appreciate, their high leverage makes a turn like the one we are experiencing much harder to manage.

I am keeping the allocation to apartment REIT's high by using the proceeds to fully fund my original position in MRG.UN.

MRG.UN remains my favorite pure play apartment REIT for reasons I've outlined before. Both MRG.UN and Preferred Apartment REIT (APTS) have been in free fall during the recent interest rate issues. The main factor in my decision to move those funds is related to the increasing leverage risk that rising interest rate's have on APTS in particular. 

Although APTS is using a high risk strategy that I appreciate, I am concerned that investors do not share my enthusiasm. On top of that there there is risk that bond prices continue their slide and negatively impact all REITs, but particularly those who are not technically profitable (net income to self-fund growth) and who are aggressively levered (APTS has debt and preferred share commitments that combined are quite aggressive). APTS depends a great deal on preferred share sales to retail investors to fund operations, and if we continue to see the risk-free rate increasing aggressively it will have a disproportionate impact on APTS share price. 

They are also not profitable, which increases risks as they require debt and equity issuance's to keep the doors open. I decided to move into a company that utilizes a similar strategy, but is more conservatively managed, MRG.UN. MRG.UN has a parent company that helps ensure that unit issuance's are priced well (as they are guaranteed demand), are a strong operator in a pure-play apartment REIT space and have a lower dividend/payout ratio which should put a higher floor in the share price. 

The other major reason for the switch is that I have the ability to DRIP into my MRG.UN holdings at this lower price point and continue accumulating easier with new contributions. I cannot do the same with APTS due to brokerage restrictions. 

I still believe in APTS and their recovery will likely be aggressive, particularly if they see no pressure to increase preferred share payout's to keep sales high. Like all leveraged entities though, they are at a disproportionate risk to interest rate changes, and the market is punishing them for it. I have lost many a holding to similar market miss-pricing and have decided to return to my previous holding for a more conservative risk/return profile. 

APTS was a value at a higher price and is a better value now, but due to it's leverage it is also (ironically) much riskier the lower their share price gets and the higher bond yields go. I have target's and minimum prices I keep in mind when I purchase companies, particularly highly levered ones, that I will tolerate before exiting. In APTS they were met a few days ago but I resisted the urge to sell immediately since I dislike trading too much... But there is a reason to have those guidelines, just liking a company will not stop it's decline. 

Depending on your personal risk appetite it might be hard to know whether doing the same would be a good idea of not. They are targeting good growth going forward and are indicating the dividend is safe (increasing next year according to guidance), but their price and new payout is being influenced by bond prices and the market may be correct about that hurting APTS disproportionately. 

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am long MRG.UN on the TSE.