Preferreds Still Offer Above-Average Yields

Published August 7, 2010


Real estate preferreds rebound; they still offer above-average yields
(New York)

HUGE RETURNS

Preferreds are an area in which investors get paid well for the risks they take, says Mr Beam. His fund returned 46 per cent in the past one year.

JOEL Beam stood out as an undergraduate at the University of California, Berkeley in the early 1990s. On a campus where jeans and T-shirts predominated, he was the one often wearing the coat and tie.

Back then, Mr Beam was a humanities major who also had an interest in real estate. As a freshman, he'd worked part time as a clerk for a local real estate developer. Then, as a sophomore, he landed an internship at Liquidity Fund Investment Corp, an investment firm specialising in distressed real estate securities.

'I remember going into the college placement office and seeing that ad and thinking this was the best internship I had ever heard of,' Mr Beam, 39, says. 'It was basically like a full-time, entry-level analyst job.'

Focus on real estate

The gig had Mr Beam rushing from school to work, Bloomberg Markets reports in its September issue. He would attend classes on rhetoric dressed in business attire so he could hop on the bus afterwards and get to his job in nearby Emeryville, where Mr Beam appraised properties and related securities. He ended up taking a fifth year to complete his course requirements at Berkeley, and after earning a degree with honours in 1994, he joined Liquidity Fund full time.

Nowadays, Mr Beam still focuses on real estate, aiming to generate income and steady returns by investing in high-yielding securities of property companies as the manager of the US$1 billion Forward Select Income Fund.

Mr Beam buys mostly preferred shares. 'It's a smaller sector of the market, and there's a really nice opportunity that we've had good success at exploiting,' says Mr Beam, who left Liquidity Fund in 1995 to join former colleagues after they started their own firm, Kensington Investment Group Inc. San Francisco-based Forward Management LLC acquired Kensington in June 2009.

Mr Beam says that preferreds are an area in which investors get paid well for the risks they take. 'So we've been able to earn pretty good returns,' he says.

The Forward Select Income Fund returned 46 per cent in the 12 months ended on Aug 4, beating 93 per cent of its peers. Buffeted by the US real estate and financial market meltdown that began in 2007, the fund gained 0.49 per cent annually during the five years ended on Aug 4; in 2009, it surged 75 per cent, according to data compiled by Bloomberg.

Preferred shares combine elements of stock and debt. Like common shares, they offer the potential for appreciation, while, similar to bonds, their fixed dividends provide regular income. Mr Beam's fund pays a quarterly dividend out of the income it derives from its preferred holdings. As at Aug 5, the fund's 12-month dividend yield was 9.45 per cent, Bloomberg data shows.

While preferred shares rank higher in a company's capital structure than common stock - meaning they have a higher priority in terms of dividend payments and in case of liquidation - they often carry no voting rights and are subordinate to a company's bonds. The universe of preferred stock is also smaller than that of common shares and bonds, and preferreds don't trade as frequently.

Preferreds issued by real estate investment trusts, or Reits, are a special case, Mr Beam says, because Reits are required to distribute 90 per cent of their income to investors. 'If they plan to stay in business and survive as a Reit, they've got to pay those dividends,' he says.

Steady earnings

Among Mr Beam's biggest holdings as at April 30 were preferred shares of Westlake Village, California-based nursing home operator LTC Properties Inc and San Clemente, California-based Sunstone Hotel Investors Inc.

Mr Beam counts LTC among his favourite holdings, given the company's steady earnings and stable business.

'I have owned this preferred for years, and it is pretty dull, but they just plug away,' Mr Beam says. 'The company has very low leverage. Their rhetoric is excellent in terms of their desire to honour their preferred and treat it like debt, which is how we look at it. I just love it.'

The real estate preferred market wasn't immune to the bust that originated in US housing and went on to roil world markets. At Kensington, the value of the Select Income Fund's assets under management tumbled to US$293 million in early 2009 from almost US$800 million in mid-2007 as securities slumped during the credit crisis, Mr Beam says. 'Prices were just sinking every day, and there was no bid for a lot of paper,' he says.

Investors value preferred securities the same way they do bonds, with a higher dividend yield implying a cheaper price.

'Our market was all over the place, and so we had an opportunity to rearrange the portfolio and buy paper that was trading at levels that we thought we would never see,' Mr Beam says.

Purchases included preferred shares of Indianapolis-based Duke Realty Corp, Denver-based ProLogis and Bloomfield Hills, Michigan-based Taubman Centers Inc. 'These were fallen-angel companies in a lot of ways, and they were basically being priced for worse than default,' he says.

The Duke preferreds, for instance, traded as low as US$6 for a yield of more than 30 per cent in early 2009. They traded at US$26.67 on Aug 5.

While real estate preferreds have rebounded, they still offer above-average yields, Mr Beam says. As at mid-July, real estate preferreds yielded about 500 basis points more than 10-year Treasuries, above their average of 365 basis points during the 10 years before the financial crisis, he says. 'These are times that we actually start to get excited,' Mr Beam says. 'We always love the product, but when it gets cheap and we know that the credit is sound, we get very excited.' -- Bloomberg