Preferred stock in Real Estate
Let’s continue our journey in the world of REITs and shine a spotlight on a lesser-known but valuable investment instrument – REIT Preferred Stock.
If you’ve ever purchased a home or property in the US, you’re likely familiar with the terms “equity” and “down payment.” Home equity is simply the portion of your home that you own outright — it’s what’s left after subtracting any outstanding mortgage (debt) balance from the property’s appraised value. Your down payment is the portion of the purchase price that you pay upfront.
In the realm of real estate investing, an equity investment is generally any amount paid to the owner in exchange for an ownership stake in underlying properties. The two most common types of equity investment are common equity and preferred equity. Preferred equity gives the investor certain preferences over other types of investors. It has a higher claim on a company’s assets and earnings than common stock. Preferred stock combines the traits of debt (it pays fixed dividends) and equity (it has the ability to appreciate in price).
REITs use preferred shares as a means of raising capital to finance their property acquisitions and ongoing operations. Unlike common shares, which are more widely known and traded, preferred shares offer unique advantages that make them an attractive option for income-focused retail investors.
Investors find preferred equity real estate investments attractive as they enjoy distinctive benefits:
More upside than senior debt-based real estate investments
Dividend payment priority over common equity holders
Downside protection (particularly attractive at or beyond a likely market peak) as they have less exposure to volatility that common shareholders may experience
Convertible Preferred Shares enable investors to participate in the potential capital appreciation when the company’s common stock shows a strong performance.
During the 2008 financial crisis, REIT common dividends were frequently cut, suspended, or paid in shares while preferred dividends continued to be paid, in cash, on a periodic basis.
While Preferred Stock offers compelling advantages, retail investors should be aware of potential challenges. These include interest rate sensitivity, limited voting rights, and call risk, which can impact the value of preferred REITs.