Are Preferred REITs Good Investments?

Real estate investment trusts, or REITs, as you may already know, are companies that own and operate income-producing properties and are required to pay 90 percent of their taxable income to shareholders. As bond-like stocks that REITs use to raise capital, preferred REITs may catch your eye as appealing investments with regular dividend payments. Issued at a par value of $25 per share, as of 2013, preferred REITs are callable, or subject to being redeemed by the company, after five years. Examples of these include Kimco Realty Pfd H (KIMpH), Pebblebrook Pfds A and B (PEBpA, PEBpB) and Public Storage Pfd O (PSApO).

Source of Income

With preferred REITs, you receive dividends paid in cash on a quarterly basis. REIT preferreds carry a cumulative dividend covenant in which the issuer is required to make up for any shortfalls in the stated dividend at a later time. Moreover, new issues have a five-year-call-protection provision, meaning that you'll have five years of fixed dividend payments without the likelihood of the shares being called in for redemption. According to investment advisory firm LDR Capital Management, REIT preferreds as an index posted positive returns 13 years out of 16, with yields of 7 percent, as of July 2013.

Low Volatility

Compared to the overall market, REIT preferreds are less volatile, with the Bank of America Merrill Lynch REIT preferred index exhibiting almost 6 percent volatility compared to nearly 20 percent volatility in the S&P 500, notes LDR Capital Management. Commercial real estate portfolio management company Odyssey Group maintains that this stems from preferred REITs being smaller issues than other traded investments, with higher yields that make them less subject to the swings of the market. Also, because many preferreds are callable at par, meaning a company can redeem outstanding shares at a set value, this has a dampening effect on prices.

Low Correlation and Diversification

Additionally, correlations to other asset classes are low, meaning that the movements of REIT preferreds do not correspond in lock-step to other investments, which is advantageous for diversification. When one market fares badly, an uncorrelated market offers a buffer against those shocks. Preferred REITs have a correlation of 0.38 as of July 2013 to the S&P 500 -- with 1 signifying 1-to-1 correspondence -- and a correlation of 0.10 to 10-Year Treasuries. Kiplinger suggests diversifying across 10 different issues, preferably new ones for a longer dividend-paying period.

Risks

Any investment evaluation is incomplete without also weighing the risks along with the rewards. Among the bevy of risks that preferred REITs can face, is the risk facing any type of REIT during a recession, when its ability to distribute dividends may be impaired. Furthermore, preferred REITs are subject to interest-rate risk, as they trade at a premium to Treasuries and a rise in yields of the latter could be harmful to preferred REITs. Because trading volume is lower than for common stock REITs, preferreds are less liquid. Takeovers could also pose problems when selling shares, unless change-of-control provisions override.