If you are an income-focused investor, your search for yield may lead to preferred stocks, especially considering bond yields are so low (the 10-year treasury is only around 2.2%) and common stocks can be too risky (many investors simply cannot handle the threat of high volatility). Preferred stocks are basically a hybrid of the two, offering characteristics of both bonds and common stocks. For your consideration this article reviews one attractive high-yield preferred stock, and one to avoid.
First, the one to avoid…
Simon Property Group Series-J, 8.375% (SPG-J)
Simon Property Group is a retail REIT. We believe the common shares are currently an attractive investment for income-investors, however the preferred shares should be avoided.
Regarding the common shares, we believe they are cheap. Basically, there is a false narrative going around that the Internet is going to put all "brick and mortar" stores out of business. And while this may be true for some stores, it's certainly not true for all of them. For example, we believe big-dividend (4.4% yield) Simon Property Group (NYSE:SPG) isn't going out of business anytime soon (SPG owns and operates premium shopping malls). In fact, SPG is growing, its shares have inappropriately sold off, and it currently presents a very attractive buying opportunity for income-focused investors that would like to see some capital appreciation too. You can read or full members-only write-up on SPG common shares here: An Attractive, Big-Dividend, Contrarian Opportunity with Significant Upside.
Regarding Simon Property Group Series J Preferred shares, we believe they should be avoided. Simply put, the market believes these shares are so safe that the price has been driven up very high, and the yield is simply unattractive. Before getting into our analysis, here is an overview of the terms from Quantum Online (*Note Chelsea Property Group merged with Simon):
Chelsea Property Group, 8 3/8% Series A Cumulative Redeemable Preferred Stock, liquidation preference $50 per share, redeemable at the issuer's option on or after 10/15/2027 at $50 per share plus accrued and unpaid dividends, with no stated maturity, and with distributions of 8.375% ($4.1875) per annum paid quarterly on 3/31, 6/30, 9/30 & 12/31 to holders of record on the 15th day of the month in which the payment is due or on the day fixed by the board, not more than 30 days or less than 10 days prior to the payment date. Dividends paid by preferreds issued by REITs are NOT eligible for the preferential 15% to 20% tax rate on dividends and are also NOT eligible for the dividend received deduction for corporate holders. In regards to payment of dividends and upon liquidation, the preferred shares rank equally with other preferreds and senior to the common shares of the company… *Note: The Simon Property Group, 8 3/8% Series J Cumulative Preferred Shares were issued to the holders of the Chelsea Property Group, 8 3/8% Series A Cumulative Redeemable Preferred Stock (PKSHT: CPGXP) during the merger between Chelsea Property Group (NYSE: CPG) and Simon Property Group that was completed on 10/14/2004.
At first glance, these terms might seem attractive considering Simon is a very safe company and the yield is very high. However, the problem is the price is too high. Specifically, the price is $70.34, and the shares are callable in 10 years at $50. And unless interest rates rise dramatically over the next ten years (they probably won't) these shares will get called. That means the share price will likely decay from $70.34 all the way down to $50 over the next ten years, and that is basically like a NEGATIVE 3.5% price return per year over the next ten years. Even though the current yield is 5.95%, the total return is only about 2.45% per year over the next 10 years! On one hand this is a testament to the safety of the company (part of the reason we like the common shares), but on the other hand you can do much better than 2.45% by investing your money elsewhere! We do NOT recommend investing in Simon Property Group's Series-J Preferred stock (but we do like the common shares).
And now the Attractive High-Yield Preferred Shares Worth Considering…
Sabra Healthcare Series-A Preferred, 7.125% (SBRA-P)
Sabra Health Care REIT owns and invests in healthcare real estate, and we believe the company's preferred shares are attractive.
Last month Sabra announced an all stock deal to merge with CCP. The transaction is expected to close in Q3, and it will have multiple diversification benefits. The combined entity will have reduced concentration risks, and the combined entity will have the following exposures.
Sabra offers a big dividend yield (currently 7.0%), but it is also risky.
One of the biggest risks is its exposure to skilled nursing facilities because Congress may reduce the amount of Medicare reimbursement payments (among other things) it makes as part of the effort to "repeal and replace" the Affordable Care Act, and this could have a significant negative impact on Sabra. If you like high yield, but you're not comfortable with the risks of the common shares, you might consider investing in Sabra's Series-A Preferred shares. For your consideration, here are the preferred share details from Quantum Online:
Sabra Health Care REIT, Inc., 7.125% Series A Cumulative Redeemable Preferred Stock, liquidation preference $25 per share, redeemable at the issuer's option on or after 3/21/2018 at $25 per share plus accrued and unpaid dividends, and with no stated maturity. Cumulative distributions of 7.125% per annum ($1.78125 per annum or $0.4453125 per quarter) will be paid quarterly on 2/28, 5/31, 8/31 & 11/30 to holders of record on the record date fixed by the board, not more than 35 days or less than 10 days prior to the payment date (NOTE: the ex-dividend date is at least 2 business days prior to the record date). Upon the occurrence of a change of control the company will have the option within 120 days to redeem the preferred shares at $25 per share plus accrued and unpaid dividends… Dividends paid by preferreds issued by REITs are NOT eligible for the preferential 15% to 20% tax rate on dividends.
Two important things to consider with regard to these preferred shares is that (NYSE:A) they only trade at a small premium to the redemption price of $25 (the current price is $25.26), and (NYSE:B) they are redeemable at the company's option in 9 months (on 3/21/2018). After adjusting for the $0.26 premium, this means you'll receive an annualized return of over 6% between now and maturity (i.e. you'll receive three more payments before they become redeemable). And considering the high rate on these shares, Sabra will likely redeem them (so they can refinance at a lower rate).
The risk with these shares is that if Sabra does not redeem them, then you'll most likely just keep receiving the big dividend payments, but the share price could fall depending on the results of the ACA "repeal and replace" effort and the industry in general. However, based on the company's most recent earnings release, it prospects are good. Specifically, Sabra raised its common dividend (a good sign), and S&P, Fitch and Moody's placed Sabra on Rating Watch Positive (also a good sign). Further, we believe the market is factoring in the worst for ACA reform, and any legislative progress would likely provide positive clarity for the shares.
Overall, we believe Simon Property Group Common shares are attractive, but the Preferred shares (SPG-J) should be avoided. On the other hand, we believe the price of Sabra's Preferred shares (SBRA-P) are much safer (less volatile) than the common shares (NASDAQ:SBRA), and the preferred shares offer an attractive yield that income-focused investors may want to consider.