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REIT Preferreds: Hotel California?



February 12, 2013 – Comments (0)

Board: Real Estate Investment Trusts

Author: yodaorange

JasperCapital said: that kind of illiquidity makes a good case for not going into those kinds of issues at all.

JC, "You can check out anytime you like, but you can never leave” is a fairly accurate description for REIT preferred owners. They are one of the most illiquid investment options that are regularly traded. I would not include them in the same category as life insurance, annuities, hedge funds and/or partnerships. But they are EXTREMELY thinly traded compared to most common stocks. They are MORE liquid that trading individual bonds.

For example, today (2/8/13), the median volume for REIT preferreds was 4,899 shares. Of issues >=$5.00 per share, 14 did NOT trade today. This is fairly common and some of the same issues regularly show up on the do NOT trade list.

Related to this is how wide the bid-ask spread is. In cases like the one I documented with the “One Share Club”, the bid-ask spread can be up to $1.00. This is NOT the norm. Maybe 10% of the most liquid issues trade with a 1 cent bid-ask spread. Since the bid-ask spread is constantly changing over during the trading day, it is difficult to quantify it with a single number. My guess is that a 5 to 7 cent spread is about the median.

The other part of this is “how deep the book” is. That means how many orders to buy, at what price and volume there are. Same for orders to sell. Let me illustrate with an example. With a broad brush, if you placed a 5,000 “market” buy order on any issue, you would buy every single share up to the “stub quote.” The “stub quote” is the dummy price that dealers use. Recall during the flash crash that issues traded for both 1 cent and $99,999. Those were stub quotes at the time. After the flash crash, dealers “tightened up” their stub quotes. That is where the ~$33.00 ask price shows up for $25 REIT preferreds. If you placed the 5,000 share buy order, probably the last 2,000 to 4,000 shares would be at $33.00. Once again, I am using generalities to make the point.

I have actually done this “experiment” several times with real money. Sometimes is was purposeful and one time it was an accident. For example, I might place a market buy order for 1,000 shares to see how it got filled. I have seen several cases where the fill range was ~$1.00 wide.

All of this reinforces the illiquidity of REIT preferreds. Investors have to understand this as part of the game if they are going to invest in them. Several times, REIT board followers have taken advantage of the illiquidity to buy temporarily depressed prices. That is fine and good.

There are broadly three types of REIT preferred holders:

1) That yield sure is great! I don’t understand calls. I don’t understand Yield to First Call. I have no idea how or when I would ever sell one of them. Have I told you how great the yield is?

2) I have a belief that interest rates will NOT spike and that I can comfortably hold REIT preferreds for the long term. The biggest risk I see is that they will be called away and I will have to reinvest at a lower yield. I understand Yield to First Call and sell issues that become irrationally priced. Sometimes I trade from one issue to the other to maximize current income.

3) I think I can spot the rising interest rate/inflation fire before everybody else. I think I can get out of the door safely before the pileup occurs. If I am wrong, I understand that I might suffer a capital loss if I sell the issue. In the meantime, I will still enjoy the high coupon yield. I might choose to hold, even if the prices go down substantially.

The question is what would happen when/if the REIT board decided to sell all? Let’s say we got a divine “Sell All REIT Preferreds” today signal. In round numbers, there are about 25 REITsters. Let’s assume they all owned the same issues. Let’s also assume they own an average of 1,000 shares per person. So we are trying to sell 25,000 shares at the same time on issues that trade ~ 5,000 shares per day. We are attempting to do 5 days of trading in one day. The prices would drop significantly. Gun to my head, I would expect the price to go down 5% to 15% in one day. Once again, this is very broad. Some issues trade a lot more and could take the 25,000 shares and NOT move the price very much.

At the other extreme, if you tried to sell 25,000 shares of my bellowed long call date SPGPRJ, PPSPRA and/or PLDGP, you would absolutely, positively HIT the lower stub quote. Matter of fact, I suspect that the dealers would turn their algorithms off and you would NOT be able to sell that many shares at any price. These are the issues that have first call dates of at least 13 years from now. As REITnut would say “they trade by appointment.”

Yoda might be incredibly foolish, yet we DO own SPGPRJ, PPSPRA and PLDGP in widows and orphans funds. Hopefully we understand the risks and know what we are in for. It is very important IMO that investors understand these risks before they buy any REIT preferreds with a substantial allocation. Buying them might mean you just checked into the Hotel California.



Here is a table of REIT preferreds plus their volume for 2/8/13.


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