Buy Alert: Grab These 8% Yielding Preferred Stocks

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Co-produced by Austin Rogers

The Preferred Stock Value Proposition

It can be easy for many investors to overlook preferred stock (PFFA). After all, preferred stocks naturally attract less investor and analyst attention. community than common equity. But income investors and retirees would do well to be wary of attractively priced, high-yielding preferred stocks, as these stocks are often consistent sources of income.

Remember that preferred stock dividends are paid after all other expenses, both operating expenses and interest payments, but before all common stock dividends may be paid. The order of priority goes:

  1. Bondholders/lenders
  2. Preferred shareholders
  3. Ordinary shareholders

All other things being equal, preferred dividends are safer than ordinary dividends because they are paid first. No ordinary dividends can be paid unless preferred dividends are also paid.

This makes preferred stock trading much like a bond, with a redemption or “par” value (usually set at $25 per share) and a par yield based on that redemption value. Most preferred shares have a call date, when the preferred shares can (but not necessarily) redeemed by the company at face value.

But, like bonds, preferred stocks can trade above or below their face value. Often, preferred stocks trade below par when investors fear that even the preferred stock dividend will need to be cut. Sometimes, however, the market overreacts and causes preferred stocks to trade below par even when comprehensive analysis suggests that the preferred dividend remains safe.

In what follows, we look at two real estate investment trust (“REIT”) (VNQ) preferred stocks with dividend yields of nearly 8% that appear to have safely covered the payouts.

Hersha Hospital Trust Preferred Series E (HT.PE)

Hersha (HT) is an upscale hotel REIT that owns upscale and upscale hotels on the East and West Coasts. The majority of its hotel portfolio is located in urban centers and attracts a wide range of travelers, from business trips and luxury vacationers to weddings and other social events.

California hotel owned by Hersha Hospitality

California hotel owned by Hersha Hospitality (Hersha Hospitality)

At the property level (considering only property-level expenses like operating expenses and mortgage payments), HT has been cash flow positive since January 2021. At the business level (also including business costs like management fees and bond interest), HT has been cash positive every month since June 2021.

Hersha Hospitality is already profitable

Hersha Hospitality is already profitable (Hersha Hospitality)

Even then, the company was quite risky because it carried significant debt: just over $1.1 billion, or about 75% of the company’s value, and the REIT has debt coming due. in 2022.

But the good news is that HT’s portfolio has rebounded from the depths of the pandemic, and they recently announced a major transaction that will see them reduce their debt by nearly 40% and manage all maturities through 2024 at less.

This greatly reduces the company’s risk, but despite this, the company’s preferred shares failed to recover and as a result, they are now undervalued.

Hersha has two series of preferred shares: Series D (HT.PD) and Series E (HT.PE). Both have yields of 6.5% at par and trade at roughly the same price. HT.PD’s call date was May 2021, while HT.PE’s call date was November 2021. Both can be redeemed at any time, but we believe HT is unlikely can allocate the capital to redeem those preferred shares anytime soon.

Preferred stock dividends are paid from species flow – i.e. net income excluding non-cash expenses such as stock-based compensation and depreciation and amortization. In the first quarter of 2022, cash flow was approximately $15 million, while quarterly preferred dividends were approximately $6 million.

Hersha Hospitality Cash and Preferred Stock Dividend
Data by YCharts

This represents a preferred dividend coverage of approximately 250%. This coverage is only expected to increase as business and leisure travel resumes.

There are at least three big reasons as to Hersha’s future prospects, at least as far as preferred stock is concerned.

  • Strong insider ownership of common stock: Insiders, including the Shah brothers who are sons of the company’s founder, own nearly 16% of the common stock. This makes them strongly incentivized and motivated to ensure the long-term success of the business and start paying a common dividend as soon as possible. But, of course, the preferred dividend takes precedence over the common dividend, which makes it much safer.
  • Fall in hotel competition in New York: In HT’s main market, New York, a significant number of hotels have closed due to the pandemic. About 10% of Manhattan’s total hotel room supply, or about 10,000 rooms, have closed. HT also expects the number of hotels in Manhattan to decline by 1-2% in the coming years. This lessens competition and should give HT’s NYC hotels a boost.
  • Back to Holiday Travel: Have you tried to book a hotel or flight recently? If so, you know travel has gotten expensive again, as everyone seems determined to make up for lost vacation time over the past couple of years. This should prove a huge boon to HT’s resort hotels, especially those in Miami and Key West.

These factors provide reassurance that HT.PE’s 7.8% yield is safe and the preferred dividend should continue to be paid in the future. On top of that, buyers at today’s price get 20% more on the cash value of HT.PE.

The Necessity Retail REIT Preferred Series A (RTLPP)

The Necessity Retail REIT (RTL), formerly known as the “American Finance Trust” with stock symbol AFIN, has a portfolio of over 1,000 multi-tenant and single-tenant commercial properties across the United States.

Shopping malls with groceries Necessity Retail REIT

Malls with groceries (The Necessity Retail REIT)

Recently, RTL announced the acquisition for $1.3 billion of a portfolio of necessity shopping centers from CIM Real Estate Finance Trust. These are electrical centers and neighborhood centers, some of which are anchored in a large grocery store. This shopping center portfolio was acquired at an attractive average capitalization rate of ~7.2%.

Once this transaction is finalized, RTL will have a real estate portfolio of 5.2 billion dollars made up of just over half shopping centers and just under half single-tenant commercial buildings (and of certain industrial buildings).

The transformation of the Necessity Retail REIT portfolio

Transformation of the Necessity Retail REIT portfolio (The Necessity Retail REIT)

Of course, we have remained cautious about RTL until today, as the REIT is externally managed by AR Global, and the external manager has a poor track record when it comes to financial management. In the past, AR Global has issued shares at inopportune prices and burdened the company with debt. Until 2021, the AFFO per share was in a downward trend even as the asset base grew.

Hence why the stock price has been in a range, at best, for years:

Necessity Retail REIT Pricing
Data by YCharts

RTL had a total debt of approximately $2 billion at the end of 2021, before the acquisition of CIM’s portfolio was completed. This represented a debt to gross asset value of approximately 45% and a net debt to EBITDA of 8.2x.

But our caution on common stocks does not translate to preferred stocks. In fact, since the start of 2021, RTLPP’s dividend coverage has only expanded.

Necessity Retail REIT Preferred Dividend Coverage

Necessity Retail REIT (YCHARTS) Preferred Dividend Hedge

By the end of 2021, preferred dividend coverage reached nearly 800%, representing operating cash flow ~8x greater than preferred dividend payout.

And yet, RTLPP’s share price has only slipped in recent weeks, reaching as low as ~$23.58. As of this writing, RTLPP is still trading around 3% below its redemption price and offering a dividend yield of 7.8%, supported by a very resilient real estate portfolio.

Also, consider that the call date for the RTLPP doesn’t arrive until March 26, 2024, giving investors nearly two more years of guaranteed high-yield income before management can repurchase shares.

Conclusion

As inflation soars and interest rates rise, some preferred stocks like HT.PE and RTLPP are selling off, providing great opportunities for income investors.

At High Yield Landlord, we are continually looking to uncover high yielding yet reliable income generators like these.