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REIT Preferred Stocks
 

REIT Preferred Stocks

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    REIT Preferred Stocks REIT Preferred Stocks Document Transcript

    • REIT Preferred Stocks An Alternative Source of Income Forward Thinking June 2009 What are REIT Preferred Securities? Real Estate Investment Trusts (REITs) are companies that develop, own and operate commer- cial properties, such as office buildings, retail centers, medical facilities and industrial ware- houses. Supported by the rental income of their underlying properties, REITs typically benefit from relatively stable cash flow and offer compelling current dividends. Established in the United States in 1960, REITs have gained wide investor acceptance due to the increased transparency, liquidity and income the structure provides. Over the last 15 years, Preferred stocks are senior to common the publicly traded U.S. REIT market has grown to 134 companies, with a market capitalization shares within the capital structure and totaling nearly $134 billion.1 offer a priority claim on the company’s cash flow. Publicly-traded companies, like REITs, may issue several types of securities—common shares, preferred shares, corporate bonds, convertible securities and secured mortgages—each with a different claim on the company’s cash flow and assets, providing varying opportunities for investor participation. Preferred stocks are senior to common shares within the capital structure and offer a priority claim on the company’s cash flow. As income investments, REIT preferred stocks typically pay higher current dividends, but have less appreciation potential and tend to offer a lower total return as compared to common shares. Figure 1 Capital Structure Hierarchy Source: Forward Management, LLC Seniority Credit Class Higher Senior Secured Bank Loans Secured Debt Senior Unsecured Debt General Trade Creditors / Subordinated Debt Hybrid Preferred Securities / Junior Subordinated Debt Traditional Perpetual Preferred Securities Lower Common Stock
    • Forward Thinking June 2009 REITs can benefit from issuing preferred securities as they are perpetual in nature and offer a more flexible financing option than bonds. The lack of a mandatory call date on the security can effectively provide permanent financing or, if the company chooses, be redeemed at a pre-established value (usually after a five year period). The typical REIT capital structure is comprised of approximately 10% preferred equity. Figure 2 Typical REIT Capital Structure Source: Forward Management, LLC Debt 50% (Bonds & Bank Loans) 10% Preferred Shares Common Shares 40% (Equity) The REIT industry’s initial growth was supported by the issuance of common equity. There was a limited supply of senior securities (preferred equity and unsecured debt) outstanding prior to 1997. Today, senior securities have become a more significant portion of REIT capital struc- tures, representing over 60% of the capital raised over the past ten years. 2 Figure 3 Historical Senior Securities Offerings in millions Source: NAREIT, 2009 Total Capital Raised Senior Securities $50,000 $40,000 $30,000 $20,000 $10,000 72% 84% 63% 64% 63% 60% 51% 60% 62% 35% $0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 REIT Preferred Socks: An Alternative Source of Income / 2
    • Forward Thinking June 2009 REIT Preferred Market Characteristics With approximately 172 issues totaling $10.9 billion in market capitalization, REIT preferred securities currently comprise 7% of the total preferred stock market and are well diversified across property types.3 Figure 4 Overall Prefered Market - Industry Diversification Source: Merrill Lynch, 4/14/09. Data as of 3/31/09. Foreign Hybrid 1% REIT 7% DRD (Dividend Senior Debt 12% Received REIT preferreds represent about 7% of Deduction) 25% the overall preferred market. Hybrid 12% Yankee 17% Euro 12% Trust 13% Figure 5 REIT Preferred Market - Property Type Diversification Source: BMO Capital Market, 3/31/09 Industrial 3% Mortgage 6% Retail 20% Healthcare 6% Hotels 6% Storage 22% Diversified 6% Other 7% Office 7% Mixed 8% Multifamily 8% While preferred securities are eligible to receive credit ratings, 13% of the Merrill Lynch Preferred Index is currently unrated. In the case of REIT preferreds, that number is over 40%, a reflection of the relatively small size of these issues.4 The typical issue size of all preferred securities is nearly $1.2 billion, while REIT preferred issues are often smaller in size, averaging approximately $64 million per issue.5 Figure 6 REIT Preferred Credit Ratings Source: BMO Capital Market, 3/31/09 Credit Rating Percent Credit Rating Percent BBB+ 11% B 1% BBB 11% B- 4% BBB- 8% CCC+ 1% BB+ 21% CCC- 1% BB 6% Unrated 43% B+ 4% REIT Preferred Socks: An Alternative Source of Income / 3
    • Forward Thinking June 2009 Portfolio Benefits REIT preferred stocks have historically offered favorable portfolio characteristics including low correlations to other asset classes and competitive dividend yields. Notably, REIT preferred securities have a historically low correlation to interest rate movements, offering potential portfolio diversification benefits to income-oriented investors. Figure 7 Dividend Yield Comparison Source: Wachovia Capital Markets, Bloomberg and NAREIT. Data as of 3/31/09. Data as of the inception date of the Wachovia REIT Preferred Stock Index (1/1/00) ending 3/31/09, based on quarterly returns. Performance of REIT Preferred Stocks measured by the Wachovia REIT Preferred Stock Index, Government Bonds measured by the Citigroup 10-year Treasury Index, Corporate Bonds measured by the Citigroup Broad Investment Grade Bond Index, REIT Common Stocks measured by the FTSE NAREIT Composite Index and Large Stocks measured by the S&P 500 Index. 14.64 15 DIVIDEND YIELD (%) 12 9.72 9 REIT preferreds stocks have historical- 6 3.70 3.61 ly offered competitive dividend yields 3 2.71 and low correlations. 0 REIT Gov't Corporate REIT Large Preferred Bond Bond Common Stock Stock Index Index Stock Index Index Index Figure 8 Low Correlation to Other Asset Classes Source: Callan Associates, Inc. Data as of the inception date of the Wachovia REIT Preferred Stock Index (1/1/00) ending 3/31/09, based on quarterly returns. Performance of REIT Preferred Stocks measured by the Wachovia REIT Preferred Stock Index, Government Bonds measured by the Citigroup 10-year Treasury Index, Corporate Bonds measured by the Citigroup Broad Investment Grade Bond Index, REIT Common Stocks measured by the FTSE NAREIT Composite Index and Large Stocks measured by the S&P 500 Index. 1.00 0.8 CORRELATION 0.6 0.56 0.4 0.32 0.2 0.12 -0.09 0.0 -0.2 REIT Gov't Corporate REIT Large Preferred Bond Bond Common Stock Stock Index Index Stock Index Index Index Dividends make up a significant portion of the total return typically offered by preferred securi- ties. Currently, REIT preferred dividends are largely well covered by the cash flows of the under- lying issuers. On average, REIT preferred stock issuers generate over $2.00 in operating cash flow (often called “EBITDA”) for every $1.00 of fixed charges (defined as preferred dividends plus interest on debt), indicating that preferred stock dividend payments appear sustainable.6 REIT Preferred Socks: An Alternative Source of Income / 4
    • Forward Thinking June 2009 With REIT preferred securities offering yields of over 14.6%, as measured by the Wachovia REIT Preferred Index, REIT preferred securities are near historically wide yield spreads to the 10-year Treasury.7 Amid continuing market volatility, the yield spread between REIT preferred securities and the 10-year Treasury hit a historic high of nearly 1,450 basis points (bps) in early March 2009. As compared to the long term average spread of 421 bps, the current spread of 802 bps as of March 31 is still high. This excess spread suggests a pricing disparity that could offer the potential for outsized returns with attractive dividend yields if spreads revert back toward historical averages. Figure 9 Real Estate Preferred Securities and the 10-year Treasury Yields Source: Wachovia Capital Markets, Bloomberg and Forward Management, LLC. Primarily based on weekly data from January 6, 1997 - May 31, 2009 Data as of the inception date of the Wachovia REIT Preferred Stock Index (1/1/00) ending 5/31/09, based on quarterly returns. Performance of REIT Preferred Stocks measured by the Wachovia REIT Preferred Stock Index, Government Bonds measured by the Citigroup 10-year Treasury Index, Corporate Bonds measured by the Citigroup Broad Investment Grade Bond Index, REIT Common Stocks measured by the FTSE NAREIT Composite Index and Large Stocks measured by the S&P 500 Index. 18% REIT Preferred Securities Yield 17.29% 10-Year Treasury Yield 16% 14% 12% YIELD (IN PERCENT) Excess spread suggests a pricing disparity that could offer the poten- 10% 8.95% tial for outsized returns if spreads re- vert back toward historical averages. 8% 6.92% 6% 4% 2.83% 2% Low Spread High Spread April 28, 1997 March 6, 2009 203 bps 1446 bps 0% Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 Conclusion We believe that REIT preferred securities provide a compelling income-oriented investment alternative, offering: • Exposure to high quality real estate companies through senior securities • Attractive dividends versus other fixed income alternatives that are generally well covered by cash flow • Portfolio benefits including low correlation to other asset classes REIT Preferred Socks: An Alternative Source of Income / 5
    • Forward Thinking June 2009 FOOTNOTES 1 FTSE NAREIT All REIT Index, March 31, 2009. 2 NAREIT, 2009. 3 BMO Capital Markets, March 31, 2008; Merrill Lynch, April 14, 2009. 4 Merrill Lynch, April 14, 2008; BMO Capital Markets, March 31, 2008. 5 Weighted average market cap. Source: Merrill Lynch Preferred Index, March 31, 2009; BMO Capital Markets, March 31, 2009. 6 Weighted average fixed charge coverage ratio for the BMO Capital Markets coverage universe, 3/31/09. 7 REIT Preferred Yield: Wachovia Capital Markets, 5/31/09. Performance measured by the Wachovia REIT Preferred Stock Index. Spreads: Wachovia Capital Markets, Bloomberg and Forward Management, LLC. Based primarily on weekly data, 5/31/09. CHART SOURCE Real Estate Preferred Securities and the 10-year Treasury Yields (Figure 9) chart source: Wa- chovia Capital Markets, Bloomberg and Kensington Investment Group, Inc. In order to achieve the longest possible time series, this chart is created using two data sources to calculate the spread. The data set is generally weekly data, with the exception of the weeks 10/06/08 and 10/13/08 which is based on daily data. The source for data from January 1, 1997 through Oc- tober 28, 2002 is Kensington Investment Group, Inc. research (as calculated on June 8, 2008) and is based on an examination of all real estate companies (including, but not limited to, REITs) and excluding mortgage companies. Data for all periods thereafter is from the Wachovia REIT Preferred Index, which is an index of preferred stocks issued by REITs (including mortgage companies). GLOSSARY A basis point (bps) equals one onehundredth of one percent. For example, 20 basis points equal 0.20%. Cash flow measures the cash generating capability of a company by adding non-cash charges (e.g. depreciation) and interest expense to pretax income. Correlation is a measure of the interdependence of two random variables that ranges in value from –1 to +1, indicating perfect negative correlation at –1, absence of correlation at zero, and perfect positive correlation at +1. Dividend yield is the sum of the trailing 12 months of cash distributions, excluding capital gains distributions, divided by the most recent net asset value. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is an indicator of a company’s financial performance. INDEX DEFINITIONS The Citigroup 10-Year Treasury Index is an unmanaged index composed of ten-year Treasury bonds and notes. The Citigroup Broad Investment Grade Bond Index is a composite of all institutionally traded US Treasury, agency, mortgage, and corporate securities. The issues must be rated at least BBB- or better, have remaining maturities of one year or longer, and have at least $25 million principal outstanding. The index is capitalization weighted. REIT Preferred Socks: An Alternative Source of Income / 6
    • Forward Thinking June 2009 The FTSE NAREIT Composite Index consists of all REITs included in the FTSE NAREIT All REITs Index that also meet the minimum size and liquidity criteria. The FTSE NAREIT Composite Index is free float adjusted. The Merrill Lynch Preferred Index tracks the performance of fixed rate US dollar denominated preferred securities issued in the US domestic market. Standard and Poor’s (S&P) 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Wachovia REIT Preferred Index is composed of REIT preferred shares. Wachovia’s Index Review Committee, which meets monthly, determines whether a security is included in the in- dex. According to Bloomberg, yields on Treasury securities at constant maturity are interpolated by the US Treasury from the daily yield curve. This curve, which relates the yield on a security to its time to maturity, is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market. These market yields are calculated from composites of quotations obtained by the Federal Reserve Bank of New York. You cannot invest directly in an index. Forward Management is a registered investment advisor. The views expressed contain cer- tain forward-looking statements. Forward Management believes these forward-looking state- ments to be reasonable, although they are forecasts and actual results may be meaningfully different. This material represents an assessment of the market at a particular time and is not a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular security. Past performance does not guarantee future results. Prices, quotes and other statistics have been obtained from sources we believe to be reliable, but Forward Management cannot guarantee their accuracy or completeness. All expressions of opinion are subject to change without notice. REIT Preferred Socks: An Alternative Source of Income / 7