REIT Preferreds Are Overlooked. Yields Range From 6% to 8%.

One generally overlooked group of preferreds are those issued by real estate investment trusts. REIT preferreds are a relatively small subset of the market at around $32 billion—equal to the preferred outstanding of just one bank, JPMorgan.

The largest REIT issuer is

Public Storage

(PSA), the big self-storage company, at about $4 billion. It has investment-grade credit ratings on its preferred.

Others are

Kimco Realty

Trust (KIM),

Digital Realty Trust

(DLR),

Pebblebrook Hotel Trust

(PEB), and Vornado Realty Trust (VNO). There also is a sizable amount of preferred issued by so-called mortgage REITs that buy mortgage-backed securities including

Annaly Capital Management

(NLY) and

AGNC Investment

(AGNC).

“The credit quality of the REIT preferred sector is very good,” says Larry Raiman, the managing principal and chief investment officer at LDR Capital Management, a firm specializing in REIT preferreds. Credit losses on REIT preferreds have been very low over the past 25 years.

Raiman points out that REIT preferreds invariably are cumulative, a favorable feature. This means that issuers need to make up any missed dividends before paying dividends on their common shares. While preferreds don’t have the same security as debt, issuers are loath to omit preferred dividends. During the financial crisis, most banks continued to pay preferred dividends in full even when common dividends were slashed.

The REIT preferred market is geared toward retail investors with most issues carrying a $25 face value and traded on the NYSE like the issuer’s common shares.

Preferreds have long been popular with individual investors because of the combination of dividend safety and yield. Preferreds are a senior form of equity. They are less secure than debt but more so than common stocks.

The retail orientation reflects the small size of REIT preferred issues, making them less liquid and therefore less appealing to institutional investors. Public Storage’s 4.10% series S issue has 10 million shares outstanding, for a total face value of $250 million. JPMorgan has preferreds with $2 billion outstanding.

The largest preferred exchange-traded fund, the $13 billion iShares Preferred & Income Securities (PFF), is dominated by bank issues. Barron’s isn’t aware of any ETFs with a REIT preferred focus. LDR offers a private fund focused on the sector.

Looking at REIT preferred, Public Storage’s 4.10% issue (PSA Pr S) now trades around $17.50 (face value is $25 a share) and yields 5.9%. Kimco Realty’s 5.25% issue (KIM Pr M) trades around $21.50 and yields 6.1%. Digital Realty’s 5.2% issue (DLR Pr L) trades at $21 and yields 6.25%. Pebblebrook Hotel’s 5.7% issue (PEB Pr H) trades around $17.50 and yields 8.1%.

One of the hardest hit REIT preferred issues is the Vornado Realty Trust (VNO) 4.45% issue (VNO Pr O) which trades around $14 and yields 8.10%. It is down about 40% this year. Vornado is one of the biggest owners of New York office buildings and has been hit by weaker demand and higher rates. The company indicated on its latest earnings conference call that its dividend would be reduced in 2023.

Annaly Capital’s 6.75% preferred (NLY Pr I) trades around $22 and yields 7.6%. Many preferreds from mortgage REITS like Annaly pay fixed rates that then shift to floating rates after five years.

AGNC has a 7.75% issue that shifts to a floating rate after five years. That unrated preferred (AGNC Pr G) is down to about $22 from its offering price of $25 in September and yields about 9%. Allen Hassan, director of preferred stock trading at Ziegler, is partial to the AGNC issue, calling it a “solid” security with a nice yield.

REIT preferred prices have dropped sharply along with the rest of the market this year as rates have risen. Many issues are down 30% or more.

Preferreds typically are perpetual, meaning they have no maturity dates. This makes them like ultralong bonds—not a good characteristic when rates rise. Preferreds usually are callable in five years at the face value of $25. This creates a bad or asymmetric return profile. Rates up, preferred is down sharply. Rates down, preferred prices are capped on the upside. The situation is better now because most preferreds are trading well below face value, creating better upside potential for investors and a more symmetric return profile.

Bank preferred offers a nice tax break since dividends are treated preferentially at a 20% federal rate like those on common stocks. REIT preferred dividends aren’t taxed as favorably because REITs have a tax-advantaged status.

However, investors can exclude 20% of REIT preferred dividends from taxation, bringing the top rate down to 29.6% (80% of 37%, the top federal income-tax rate).

“You get a deduction equal to 20 percent of the ‘qualified REIT dividends’ received during the year,” says New York tax expert Robert Willens. “This would include dividends on REIT preferred stock as well as dividends paid with respect to a REIT’s common stock.”

 Write to Andrew Bary at andrew.bary@barrons.com