REIT Report

Market analysis by our public securities expert, Geoff Shaver

March 22, 2020

What Opportunities Exist Today in REIT Preferred Stocks?

Geoff Shaver, Director of Public Securities

by Geoff Shaver
Director of Public Securities

There’s no doubting that the stock markets have been volatile lately. But, this panic-induced sell off has led to some new buying opportunities. Those looking to “bottom fish” might find opportunity in hotel or mall real estate investment trusts (“REITs”), as they are hurting for sure. But if you’re looking for the potential of a solid risk-adjusted return that comes with a steady stream of income, you might take a look at REIT preferred stocks. We’re starting to see some real value there, especially in some companies and property types that we feel will be around even under a worst-case Covid-19 scenario. We encourage you to take a look at preferred stock issued by Digital Realty Trust (DLR), Public Storage (PSA), and American Homes 4 Rent (AMH).

Before we dive into these three REITs, let’s do a quick review. A REIT preferred stock sits in the capital structure between stocks and bonds. The dividends of preferred stocks have priority over common dividends, and most of the preferred stock issued by REITs is cumulative, meaning any missed preferred payments must be made in full before the common shareholders can receive any dividends. Preferred generally have liquidation preference over common stock as well. Generally speaking, preferred stock should be less risky than common stock.

Let’s dive into the preferred stock issued by Digital Realty Trust (DLR), Public Storage (PSA), and American Homes 4 Rent (AMH).

Digital Realty Trust owns, develops, and manages technology-related real estate, mainly data centers, and they were the first public data center REIT. Demand for data center space has been growing over the past decade. In fact, the recent coronavirus events have likely heighted the need for connectivity and data center space, as we have seen a marked pickup in internet traffic. Emerging technologies, such as driverless cars, virtual reality, and artificial intelligence will add to this demand in the future as well. DLR has several series of preferred stock outstanding, and we will focus on the series K. On March 19, 2020, the DLR-K had a current yield of 6.7% and closed at $21.93. We particularly like preferred stock from DLR as there is a $34.8B1 equity buffer protecting the preferred position. Furthermore, DLR has increased their common dividend every year since their IPO with the most recent increase coming in February 2020. (As you recall from above, the preferred stock must receive their dividend before any can be paid on the common.)

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Next, let’s look at Public Storage, which owns, acquires, develops, and operates self-storage facilities; they are the largest self-storage REIT in the U.S. Self-storage is often viewed as a defensive play in real estate as the need for self-storage isn’t necessarily tied to GDP or job growth, but more so tied to life events such as moving, having a baby, or getting a divorce. Even if you just need more space for your stuff, it’s cheaper to rent a self-storage unit than buy a bigger house. And just where do you think people are going to store all that extra toilet paper and other goods they stocked up on when they get tired of seeing it in their living room? PSA also has several series of preferred stock outstanding, and we will focus on the series W. On March 19, 2020 the PSA-W had a current yield of 5.9% and closed at $22.04. Not only does PSA have a sizeable equity buffer at $32.8B2, but they hardly use any debt, with less than $2B of debt outstanding on their balance sheet as of December 31, 2019. What this means is that $32 billion of equity needs to get wiped out before the preferred equity position is at risk. This isn’t to say it can’t go lower in price, but even if it does, this a cumulative preferred stock so the company has an obligation to pay it before the common equity dividend. And, while the common dividend can always be eliminated entirely, the preferred dividend accrues even when it does get cut.  In any case, we believe that scenario is extremely unlikely, but this is some of the risk protection a preferred security offers over common equity.

The third REIT, American Homes 4 Rent, focuses on acquiring, renovating, leasing, and operating single-family homes in the United States. REITs that own single family rental properties are a newer phenomenon that was born out of the great financial recession, and AMH was the first to list publicly. Whatever property types fall by the wayside during these Coronavirus events and likely economic contraction, people will still need a place to live. We believe that in the near term for renters, the most likely action for many is to renew in place, and with AMH ending 2019 at 94.9% they started the year at a pretty full level. We could even see a new surge in single-family renters in the future as Millennials decide to start raising families. AMH has a couple of series of preferred stock outstanding and we will focus on the series H. On March 19, 2020 the AMH-H had a current yield of 7.8% and closed at $20.15. AMH has an equity cap of $7.3B3, and while not as much as DLR or PSA, we feel they have a very healthy balance sheet, and you are compensated for the extra risk with a higher yield.

In summary, we are seeing some opportunities in preferred stocks issued by companies that we believe will be around long after the coronavirus and related events have passed. These preferred stocks come with enticing yields and even have the potential for capital appreciation, if the preferred can trade back to or above par value. Some of these companies have large common equity capitalizations that will protect the preferred position, which has priority on dividends and in liquidation.

Our Income REIT Block includes REIT preferred stocks from a variety of property types and is made for an investor whose primary goal is to generate a steady stream of income. Download the Path app to learn more about this REIT Block and see if it might be a good fit for your portfolio.

Read more recent articles on REIT investing

1 From company reports, SEC Filings, and stock prices from Google Finance
(Shares and units outstanding at 12/31/19 + shares issued under forward equity offering + shares issued in connection with INXN merger) x ($125.27 closing price on 3/19/20)
2 From company reports, SEC Filings, and stock prices from Google Finance
(Shares and units outstanding at 12/31/19) x ($187.60 closing price on 3/19/20)
3 From company reports, SEC Filings, and stock prices from Google Finance
(Shares and units outstanding at 12/31/19) x ($20.78 closing price on 3/19/20)
Geoff Shaver, Director of Public Securities

Geoff Shaver

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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Disclaimer

Geoff Shaver and clients of Path by Origin, LLC own DLR, PSA and AMH. Neither Mr. Shaver nor Path have a business relationship with any company whose stock is mentioned in this article.

Path by Origin, LLC (“Path”) is an SEC registered investment adviser.  Mr. Shaver is the Director of Public Securities of Path. The views expressed herein are subject to change, and no forecasts can be guaranteed. The comments provided are for educational purposes only and may not be relied upon as recommendations, investment advice or an indication of trading intent. In preparing this document, the author has relied upon and assumed, without independent verification, the accuracy and completeness of information available from public sources.  The stocks mentioned in this article have been highlighted based on some reported news, quality or characteristic and do not necessarily represent all of the securities recommended for a particular portfolio.  Path is not soliciting any action based on this communication.  Investments involve risk, including the possible loss of principal and fluctuation of value.  Past performance is not indicative of future results. Mr. Shaver and Path disclaim responsibility for updating any information herein. In addition, Mr. Shaver and Path disclaim responsibility for any third-party content.