Preferred Securities Part 1 - The best global REIT opportunities are in North America

Article10 mins01 December 2023By Richard Stone

This article is part of a series, for part two, click here 

As global REIT specialists, delivering competitive risk-adjusted returns underpinned by income is our top priority. And right now, the best place in the world to help us do that is North America. The reasons are circumstantial and structural. In unison, they make a powerful argument to Australian investors; now is a good time to be looking at investing in North American REITs.

One of the most compelling reasons concerns a component of the REIT capital structure unavailable in Australia. REIT preferred securities help fund North American REITs, assisting them to meet their rolling capital requirements. They’re publicly listed and can be repaid at the time of the REIT’s choosing. The attractions for investors are equally alluring. Let’s begin with six structural advantages of REIT preferred securities.

Benefit #1: Relatively high income compared to REIT common shares.

As the chart shows, REIT preferred securities typically deliver higher levels of income compared to US REIT common shares.

Source: LDR Capital Management June 2023

Of the preferred securities we cover, the average yield is about 3% higher than that of the ordinary shares of US REITs. For investors focused on reliable dividends, that’s an attractive premium.

Benefit #2: Reliable income stream.

What is the point of a premium yield if it also entails one or two missed payments, playing havoc with a supposedly stable income stream? This is where preferred securities come into their own. The table below shows the relatively high maintenance of distribution payments by US REIT preferred securities compared to US REIT common equities during the pandemic from December 2019 to July 2020.

 Dividend payment status  # of REITs
 Suspended Preferred Dividends  5
 Reduced or Suspended Common Dividends  79

Source: LDR Capital Management July 2020

Whilst preferred securities met 95% of their expected distributions, US REITs managed just 88%. Being able to meet almost all their distribution commitments during an unprecedented global pandemic gives us great confidence in the ability of preferred securities to deliver a relatively high and sustainable yield.

Benefit #3: Resilience through lower volatility.

History suggests REIT preferred securities are also resilient. Our sample analysis suggests that preferred securities have been about two to three times less volatile than their ordinary share equivalents.  Our holdings in preferred securities have been a major contributor to the Dexus Global REIT Fund achieving its lower than index risk objective since its inception .

Benefit #4: Price appreciation.

During the pandemic, we were able to establish our portfolio when many of these securities were trading below face value. The result is a portfolio with highly defensive attributes, substantial capital growth and relatively high, risk-adjusted income-based returns.

Benefit #5: Big opportunity set.

With about 100 individual REIT-issued preferred securities in the US and a market capitalisation of A$25 billion, this is a deep and diverse market. Covering multi-family residential, manufactured housing, self-storage, office, logistics, health care, discretionary retail, data centre and other sectors, it’s an attractive hunting ground.

Benefit #6: Higher capital stack ranking.

REIT preferred securities have a higher ranking and preference within the capital stack, which defines the rights to the income and profits from the assets and the order in which they are distributed. Preferred securities rank lower than senior debt holders but ahead of equity investors. This means they will receive their distribution after debt holders but before ordinary shareholders. And unlike the dividends from ordinary shares, which can be reduced or cancelled in times of stress, any missed coupon payments must eventually be paid to investors, usually in the form of a predetermined fixed quarterly coupon.

Why preferred securities are attractive now?

These six structural factors explain why preferred securities offer a more reliable source of income than a standard REIT equity investment. But makes them attractive now? Whilst preferred securities are different to ordinary shares, like traditional shares they are sometimes available at a discounted price. 

That’s the case right now. The headlines around issues in the office and hotel sectors, for example, mean stocks owning assets of that type are deeply out of favour. Many preferred securities, which we judge will experience no problems paying their quarterly distributions, are being treated in the same way as their ordinary shares. 

Just as they were during the pandemic, as sentiment overwhelms a rational view of value, in many cases the discounts are attractive. This is what has us excited. We really didn’t expect to get a second bite of the preferred security cherry so quickly, but here we are.

Is there a catch? 

Of course, detailed due diligence of the individual covenants attached to every preferred security is essential before investing. This is where we believe we have an edge. This area of the market has been a key part of the Dexus Global REIT Fund since its launch in April 2020. We wouldn’t call preferred securities the secret sauce of the Dexus Global REIT Fund, but they certainly add some spice, with ingredients that simply aren’t available in Australia.

In part two, to be published in the next few weeks, we’ll look at the specialised investment process for investing in REIT preferred securities, and a couple of case studies that made it through into the portfolio.

This article is part of a series, for part two, click here


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