Market analysis by our public securities expert, Geoff Shaver
March 3, 2020
Can REIT Preferred Stocks Help Your Portfolio Withstand Market Volatility?
by Geoff Shaver
Director of Public Securities
Last week we saw quite a down draft in the U.S. (and global) equity markets likely on the back of coronavirus fears – and the listed REIT market was no exception. For the week that ended February 28, 2020, we saw the price of the S&P 500 drop by -11.5% and the tech-heavy NASDAQ Composite fall by -10.5%1. Listed real estate investment trusts (REITs) didn’t fare any better, with the FTSE Nareit All Equity REITs Index falling by -12.4%. After large movements up or down, it can be a good idea to make sure your personal asset allocation is still in line with your target. If you found your stomach turning as you looked at your portfolio this week and last week, it’s probably time to revisit your asset allocation.
Asset allocation means that your portfolio has been designed to accomplish your risk and return objective. Make sure your weightings in stocks, bonds, real estate (both public and private), and other asset classes are still within acceptable risk tolerances for your needs. The barbell strategy of only having stocks and bonds in a portfolio may look balanced but it can also lead to tremendous volatility and in my opinion, isn’t optimal. (The barbell structure means you only have representation in the riskiest, stocks, and most conservative, bonds, part of the capital structure.) In between these two extremes is something called preferred equities, which are often under-represented in portfolios.
A REIT preferred stock sits in the capital structure between stocks and bonds and has fixed income like qualities but may have a higher yield. Over the same one-week period mentioned above, REIT preferred stocks fell in price by just -4.7%3, as measured by the MSCI US REIT Preferred Index. With a dividend yield of 5.90%4 on this REIT preferred index, this price decline represents less than one year of returns. It would take over five years for dividends from the S&P 500 5 to make up for the price loss in the S&P 500 index. While the REIT preferred performance was much better than what we saw in the U.S. broad market and REIT equity indices, the move in interest rates would have suggested we should have seen a positive price movement in preferred stock. We believe that may be coming.
In 2019 REIT preferred stocks performed very well as interest rates in the U.S. fell. We saw the U.S. 10-year treasury start the year with a yield of 2.69% that fell to 1.92% by the final day of the year, a drop of 77 basis points6. Over the course of the same year the MSCI US REIT Preferred Index had a total rate of return of +19.9%7. This is exactly the sort of inverse relationship we would expect to see between interest rates and fixed income securities. That is when rates go down, the value of preferred securities should go up.
However, we believe that credit risk is always a concern in preferred stocks. If we look at a specific REIT preferred stock, for instance the PSA-W 5.200% Series W Cumulative Preferred Stock (“PSA-W”), we see that the yield ended last week at a rate of 5.26%8. That’s 424 basis points above the ten-year treasury9 as of the time of this writing. Given their strong balance sheet and limited use of debt, we believe there is a fairly low risk of PSA-W not paying the dividends on their preferred stocks any time soon.
PSA-W is one of several preferred stocks that make up our Income REIT Block. Download the Path by Origin app to learn more about this REIT Block and see if it might be a good fit for your portfolio.
1 From Bloomberg, for the period February 21, 2020 through February 28, 2020
2 From U.S. Department of the Treasury, for the period February 21, 2020 through February 28, 2020
3 From S&P Global Market Intelligence, for the period February 21, 2020 through February 28, 2020
4 From MSCI fact sheet for the MSCI US REIT Preferred Index dated January 31, 2020
5 From Bloomberg, as of March 1, 2020 the dividend yield for the S&P 500 Index was 1.95% for the trailing twelve months
6 From U.S. Department of the Treasury, for the period December 31, 2018 through December 31, 2019
7 From S&P Global Market Intelligence, for the period December 31, 2018 through December 31, 2019
8 From Bloomberg, pricing for February 28, 2020
9 From U.S. Department of the Treasury, the U.S. 10-year treasury yielded 1.02% on March 3, 2020
Director of Public Securities
Geoff leads the construction and monitoring of the public real estate securities portfolios available in our Path by Origin app. Prior to Origin, Geoff spent the last 12+ years researching and investing in public REIT securities at both Duff & Phelps Investment Management Co. and J.P Morgan Asset Management.
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