Flood Of New High Quality Preferred Stocks Coming?

During the last real estate boom (2005/2006), Real Estate Investment Trusts (REITs) introduced a large volume of corporate bonds (about $27 billion). Many of these bonds carry five year maturities and will be coming due soon.

A May 26, 2010 Wall Street Journal article makes the case that REITs are likely to be issuing new preferred stocks shortly in order to raise the capital needed to retire these boom-era bonds.

Supporting this point of view is that fact that, while high quality preferred stock dividend rates have now been restored to pre-crisis levels, the federal funds rate, which corporate bond interest rates are more closely tied to, is still artificially low. The theory being that as the Federal Reserve begins to raise the federal funds rate (which we all know they will have to do since the current rate is essentially zero), corporate bond rates are likely to go up while preferred stock dividend rates may stay unchanged, at least for some period of time.

Historically, the spread between the federal funds rate and high quality preferred stock dividend rates runs between 2% and 5%; right now the spread is at 7%, further suggesting that there is room for the federal funds rate and corporate bond rates to rise before we see an increase in preferred stock dividend rates.

If the federal funds rate and, commensurately, corporate bond interest rates come up, while high quality preferred stock dividend rates stay flat, the WSJ article could very well prove to be correct. We would see fewer corporate bonds and more new preferred stocks used to generate the capital needed to pay off maturing boom-era REIT debt.

While during the crisis it was banks that were issuing the bulk of the highest quality preferred stocks (all the way up to 9.6% without a single dividend being missed), it could very well be REITs that lead the next wave of new high quality preferred stock issues.

The new 6.875% issue from Public Storage (a REIT) may be the first of what could be many new high quality issues for preferred stock investors to consider.

Many Happy Returns.