Setting aside my personal view on preferred, note that doesn’t stop me from buying them; I compartmentalize and carry different views simultaneously.
Now, if an investor is getting warmed up because of the 5.5% ~ 6% and in some cases slightly higher dividend yield, here are the factors I would consider:
Yesterday J Powell in his interview to marketplace.org, made some pretty hawkish comments
75 basis point raise on the next meeting is on table (meaning it is most likely going to happen)
He is going to keep raising until inflation comes down
“hard landing” is possible
So, how do we know when Fed will stop?
Inflation coming down meaningfully (by the time Fed sees the inflation tamed in their numbers; probably the damage is done)
there is one scenario where Fed might change course regardless of inflation is, if Credit completely stops, like 2018 or 2020. In both scenarios Fed pumped liquidity into the market.
So Either inflation comes down or until then Fed keeps raising interest rate;
If the interest rates has gone up too high, then credit dries up, or inflation comes down.
So, If Fed is going to raise rates by another 1.5% to 2%, what it will do to dividend yield? they will go up, meaning the prices will go down.
I will sit tight. Sit tight, preserve cash. Market will present opportunity. Before fed gets done, we may have interim rallies, be careful about getting sucked into it.
I have never been a big fan of fixed income including preferreds. This has prevented me from buying them until they were compelling bargains hence I have always done well on them.
The preferreds that I have bought that were current on their payments, were bought at prices of about $17.625 to $21.75 and had nominal yields at par of 7.875% to 9.25%. After factoring in the discount to par, all had current yields north of 10%. That is my bogey, I will only buy a preferred when it is of reasonable quality and has a current yield of above 10%.
I acknowledge that I may never get such opportunity again.
My only other fixed income investments have been closed-end bond funds selling at discounts of 15% to 35%. I may never get such an opportunity again there either, but I think 15-20% discounts perhaps as early as December of this year is remotely possible.
One of my gages of buying fixed income is the years it takes a dividend growth stock to match the income of the fixed income. The older I get the lower this number needs to be.
Using O and 3.5% DGR it will take O 11 years before its dividend will exceed 6% fixed income.
That 11 years stretches out to 14 years if the fixed income excess is re-invested in more fixed income each year (I.E. $10,000 of O generates $439.10 in income year 1 versus $600 for Fixed. The $160.90 excess can be invested to create $9.65 in year 2 fixed income, etc.).
Now just suppose the O is trading for $75 versus current price of $67.41 the years stretch out to 20+.
Of course when O gets to $75 I’ll likely sell CC’s against my O shares as I have in the past.
When O gets too cheap I’ll sell PUTs too.
John
Long preferreds at 5% of portfolio (and growing)
Long O, short 6/17/22 $85 CC’s sold on 10/25/2021, short 6/17/22 $57.50 PUTs sold on 3/1/2022.
OK, sell O for $85 or buy for $57.50. I’m happy if either happens.
From your description, you are very disciplined and structured in your approach. I believe I have had a broadly similar POV without stating it formally like you did. I have owned preferreds since the mid 1990’s, sometimes having as many as 10 holdings (this was during the 2010 recovery stage). Often times I have had zero or just a couple of them due to the category not being “on sale” like you describe. Buying below par is a core requirement.
The only ones I have owned in the last few years were MNR-C which was called at par in late Feb due to the parent company being bought out. I had PSB-X which was I bought at a modest discount and sold at $25.20 at the end of March. My sale was triggered by my expectation that rising rates would likely keep my shares from seeing par for awhile. The parent company being sold in April gave a nice windfall to common shareholders but saw a steep selloff of all their preferreds. I never could figure out why the prices dropped to the $18-19 range (they are now around $20). BTW, PSA owned about 40% of PSB so PSA common shareholders will have a large windfall coming their way depending on how the parent intends to distribute the proceeds.
In a recent thread the PSA preferreds were talked about. I don’t recall owning any of them as they tended to be among the lower yielding issues. When I looked up some of the recent issues, I saw that buyers had paid $27-28 for them last summer and fall. That highlights one of the things that I always liked about these critters (as our old friend Ralph used to call them). They are usually very thinly traded. Many of those buying them have little or no idea how they work or can work. One can often take advantage of that on either side of the trade. Holding on to a preferred when it is selling for a $2-3 premium is a fools game. But there are always people out there who only see current yield. They fail to grasp that paying a premium of 2-3 years worth of dividends on a security that can be called at par or drop well below par can give you a gut punch version of reality.
What is hard for the uninitiated to learn is that a severe drop in price generally has little to do with the soundness of the parent company. New issues hitting the market place at higher or much higher rates HAS to push down the price of a lower yielding preferred until it is somewhat comparable to new issues.
I have the sense that there may be some great opportunities down the road as the Fed raises rates often and significantly. There is the old saying that if the only tool you have is a hammer, then everything you see looks like a nail. The Fed is in a strong hammering mode. Their actions should provide some good prices. The danger is that all that hammering may do some other unplanned damage that cannot be repaired so easily. A screaming buy of a healthy REIT preferred at say $18 is only a good buy if the road to larger economic recovery doesn’t have too many deep potholes and “Bridge Out” signs.
I hope some of our lurkers can be persuaded to add their $.02 on the subject as it is a subject where lots of input is always appreciated. Thanks to all who have already participated.
“What is hard for the uninitiated to learn is that a severe drop in price generally has little to do with the soundness of the parent company.”
When I see a preferred dropping like a rock, I like to look at the common. I have seen a preferred down 3-4% for the day, when at the same time the common is up.
I’m in the “wait until interest rates go up higher and preferred yields follow” camp.
Looking at PFFA, it sure has a high net expense ratio; as I post, it is 1.21% on a distribution yield (TTM) of 8.34%…so, one pays almost 15% of the current distribution yield to the folks that manage it: too high for my blood.
I think right now is a good time to buy some preferreds. I require a rate of 6.5 - 7.5%. I could live
with that if it were never called (something you have to consider with rates rising). I would only buy
preferreds of companies that are in certain sectors or industries. In general I would avoid preferreds
of REIT’s that own malls and offices. I prefer REIT’s that own apartments, industrials and storage
facilities. I have bought some preferreds that are callable in about 1/2 year. An example is CSR-C, an
apartment REIT preferred that pays 6.625% and is callable 10/2/22. It is currently selling for $25.01.
Another is UMH-D they own manufactured home communities, pays 6.375% and is callable 1/22/23. It is
currently selling at $ 24.64. I bought some earlier today at $ 24.80. According to my calculations,
yield to call is 7.57%. Even if it is not called, I will still get 6.42% to hold it. If you can buy
PLYM-A for under $ 25.15, it is a terrific bargain (yield to call would be at least 6.5%). It is an
industrial REIT. paying 7.5% and is callable at 12-31-22. I was able to buy some recently at $25.25.
I settled for that as it still had a yield to call of around 5.9%. My thinking is preferreds with calls
of less than one half year will likely not drop below par very much, and I can reevaluate what I want to
keep down the road and still get a nice return for that short period. It would be wonderful if PLYM-A
was not called and I kept getting about 7.4% on my money.
I have also recently bought 2 bank preferreds AUBAP (parent AUB) and UCBIO (parent UCBI). Both are
preferreds of community banks that have performed well. The banks are quite similar, as are their
preferreds. Both pay 6.875%, were issued in September of 2020, and are callable in September of 2025.
AUBAP is currently priced at $24.95 and UCBIO at $25.64. I recently bought each of these right near
par. At $25.25 the yield to call would still be about 6.5%. You might have to be patient to get UCBIO
at par, but AUBAP is already there. I would buy more of each, if I didn’t already have a lot. The only
thing I don’t like about them is they are not cumulative (like most bank preferreds).
Norm
I bought capital one and publis storage preferred recently like 10 days back… down already by 5% … not sure with 10 year around 4.75 - 5%, preferred at 6.75% makes sense? I am not buying anymore - just holding on to what i bought recently
I understand the prices are down is unpleasant. But, if you are looking for fixed income, #1 rule is don’t buy preferreds there is no such think as safe preferred, especially REIT ones. See what is going on with erstwhile PSB preferred. REITs have shown they can and will treat preferred holders badly, cheat them. Currently no regulatory agency is there to protect you.
Look at Bonds, they offer legal protection and currently you are going to get better yield.
Lastly, remember 5% UST is actually not outlier rather normal. The ZIRP regime of 2009 to 2022 is the real outlier. Don’t let the recent past cloud your views. No one knows future but if you could 7% or 8% on long dated instruments that are safe (don’t reach for yield and buy suspect instruments) you should be okay.
The reason is US federal government cannot sustain this high interest rates, they will make sure FED brings interest rate down and when they do, value (in fixed income securities) will outperform and the yield you are trying to reach can explode before we get there.
