Is it time to start thinking about preferred stocks as a way to supplement yield and counter the volatile swings in today’s market? No other investment security toils in such obscurity as preferred stocks. Yet today there is reason to give these securities a serious look. Preferred stocks are financial instruments that combine the characteristics of both debt (fixed dividends) and equity (potential appreciation). Some quality REIT preferred stocks have yields exceeding 8%. For instance, luxury hotel property REIT LaSalle Hotel Properties (LHO) 7.25% Series G Preferred trades with a yield of 9.24%. In early November, the yield for LHO-PG was 8.10%. Eight months earlier it was 7.35%. That’s a little over a 110 basis point rise in yields in little over a month and nearly 200 basis point rise in yield in less than a year.
A cursory review of the Company's financials and business indicate a company that is not at risk of failing to be able to service its debt.
The Company revised its 2007 FFO per diluted share outlook to $3.11 - $3.15 and its anticipated hotel EBITDA margin outlook to an improvement of 80 - 100 basis points.
The ratio of EBITDA to Distributions to Preferred Shareholders is 8.4. It’s interest coverage ratio (EBITDA to interest expense) is 5.4, a comfortable margin.
In it's third quarter October 17 earnings press release the Company had this to say about the Company's prospects. "The fundamentals for the lodging industry remain favorable and we continue to see strong demand in the major urban markets," said Jon Bortz, Chairman and Chief Executive Officer of LaSalle Hotel Properties. "As the repositionings at our properties are completed later this year and in the early part of next year, we anticipate their performance to not only benefit from continuing favorable market conditions, but also reap the benefits from our extensive capital investments.
Not exactly the sentiment one would expect to find for a business on the brink of collapse or at risk of falling into default on it's financial obligations any time soon.
Is it time to start thinking about preferred stocks as a way to supplement yield and counter the volatile swings in today’s market? No other investment security toils in such obscurity as preferred stocks. Yet today there is reason to give these securities a serious look. Preferred stocks are financial instruments that combine the characteristics of both debt (fixed dividends) and equity (potential appreciation). Some quality REIT preferred stocks have yields exceeding 8%. For instance, luxury hotel property REIT LaSalle Hotel Properties (LHO) 7.25% Series G Preferred trades with a yield of 9.24%. In early November, the yield for LHO-PG was 8.10%. Eight months earlier it was 7.35%. That’s a little over a 110 basis point rise in yields in little over a month and nearly 200 basis point rise in yield in less than a year.
A cursory review of the Company's financials and business indicate a company that is not at risk of failing to be able to service its debt.
The Company revised its 2007 FFO per diluted share outlook to $3.11 - $3.15 and its anticipated hotel EBITDA margin outlook to an improvement of 80 - 100 basis points.
The ratio of EBITDA to Distributions to Preferred Shareholders is 8.4. It’s interest coverage ratio (EBITDA to interest expense) is 5.4, a comfortable margin.
In it's third quarter October 17 earnings press release the Company had this to say about the Company's prospects. "The fundamentals for the lodging industry remain favorable and we continue to see strong demand in the major urban markets," said Jon Bortz, Chairman and Chief Executive Officer of LaSalle Hotel Properties. "As the repositionings at our properties are completed later this year and in the early part of next year, we anticipate their performance to not only benefit from continuing favorable market conditions, but also reap the benefits from our extensive capital investments.
Not exactly the sentiment one would expect to find for a business on the brink of collapse or at risk of falling into default on it's financial obligations any time soon.
It should be noted that the Company's Preferred Shares rank senior to the common shares of beneficial interest and on parity with each other with respect to payment of distributions; the Company will not pay any distributions, or set aside any funds for the payment of distributions, on its common shares of beneficial interest unless it has also paid the full cumulative distributions on the Preferred Shares for the current and all past dividend periods. To date the company has not cut or lowered its dividend payout to common shareholders, and in fact, continues to payout a healthy return. Certainly any adverse change in the common dividend would signal a need to for concern regarding the preferred shares. As for now, the common dividend appears to be safe.
Lastly, for the nine months ended September 30, Total Portfolio Occupancy rose 0.2% (even while pulling 6000 rooms off the market for renovation), ADR (average daily room rate) rose 4.4% to 199.72, and RevPAR (room revenue per available room) increased 4.6%.
Again, not the kind of financial results one would expect to see for a company on the precipous of poor financial straits.
What is going on here? Well for one, the crisis in the sub-prime mortgage market has spilt over into all forms of “debt” securities. The credit markets have seazed up due to a lack of liquidity brought on by the ongoing mortgage market turmoil. No market has been spared.
With turmoil comes opportunity. As large institutions (primarily the banks) are forced to write down the value of their portfolios, they bump up against capital requirements and are thus forced to sell assets. Due to a lack of liquidity in the financial paper (primarily mortgage backed securities) that they are having to write down (or off) their books, banks and other holders of mortgage paper are forced to sell more liquid assets, such as preferred stock. This action puts downward pressure on the price of preferred stocks and causes yields to rise in order to attract buyers.
In my opinion, it is a classic case of throwing out the baby with the bath water. Also, because REITs are real estate properties, they are painted with the same brush as all mortgage securities. However, not all real estate is created equal. Luxury hotels are a far cry from the assets backing sub-prime loans. Additionally, investors fear an impending economic recession and the accompanying decline in occupancy rates. Prospects of an economic downturn bring with them fears of rising loan default rates, especially as rates ratchet up on adustable rate loans. I would contend that these fears are overblown. Central banks around the world have been vigorously injecting liquidity into the financial markets to “prop up” the banks and reinvigorate lending (today alone, the European Central Bank injected $500 billion into the system – a massive operation). Although the sub-prime mortgage and housing market are not out of the woods by any stretch of the imagination, the Federal Reserve and other central banks have made it clear (from their actions) that they will come to the rescue should there be further fallout from the crisis.
I would expect the Fed to lower rates, at the least, another 100 – 125 basis points over the course of the next six months. If that occurs, that would bring the funds rate down to around 3.00% from its current level of 4.25% assuming a full 125 point decline. The U.S. Treasury ten year note would likely fall in yield to around 3.5 – 3.75%. Those are pretty paltry yields in comparison to today’s 6% and 7% yields on AAA/BBB corporate preferreds, 7% yields on BBB utility preferreds, and 8% and 9% yields on REIT preferreds.As well, as the economy steers clear of running aground in 2008, fears of rising defaults will subside lifting fixed income prices.
For investors in high tax brackets, you may want to focus on preferred stocks which only pay tax-qualified dividends.
For more information on preferred stock investing, see my recent articleposted on this site.
Sampling of preferred stock yields by credit quality:
There are more than 900 issues tracked by QuantumOnline, the majority of which are in the utility industry. But banks, insurance companies and certain energy companies are well represented. Here are a few for starters, all (with the exception of REITs) of which pay tax-qualified dividends:
Utility Preferreds
Baa1 / BBB+
Alabama Power 5.20% Preferred Series N [ALPPRN]. This company is a stable and prosperous subsidiary of utility giant Southern Company (SO). At current prices, it has a current yield of 6.39%.
Baa1 / BBB-
Baltimore Gas & Electric Co., 6.99% Series 1995 Cumul Preference Stock (BGLEP.PK). Current yield 6.82%.
Baa1 / BBB+
Southern California Gas Co., 6% Series A Cumulative Preferred Stock (SOCGP.PK). Current yield 6.74%.
REIT Preferreds
Baa2 / BBB-
AMB Property Corp., 6.85% Series P Cumul Redeem Preferred Stock [AMPPRP]. Current yield is 7.98%.
B1 / B-
Host Hotels & Resorts Inc., 8 7/8% Class E Cumul Redeem Preferred Stock [HSTPRE]. Current yield is 8.8%.
Bank Preferreds:
Aa3 / A
Royal Bank of Scotland $1.53 Series Preferred R [RBSPRR]. The current yield is 7.95% on an S&P Grade A security from this large bank.
Aa2 / A+
BAC Capital Trust VIII, 6.00% Capital Securities [BAC-Z]. Current yield is 7.41%.
If you aren’t ready to go out and pick up individual preferred shares on your own, you might want to consider a closed-end fund or mutual fund that specializes in preferred stock. Better yet, take a look at the S&P U.S. Preferred Stock Index fund (PFF) an ETF that owns the preferred stocks in the S&P index.
Disclosure: The author owns preferred stock positions in both LASALLE HOTEL PROPERTY 7.50% SERIES D PREFERRED (LHOPRD) and HOST HOTELS & RESORTS INC PREFERRED E 8.875% (HSTPRE).
