Help me understand preferred stock we own...

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jbrinker
Posts: 68
Joined: Wed Sep 24, 2014 1:33 pm

Help me understand preferred stock we own...

Post by jbrinker »

As part of a private REIT redemption, we received part cash, and part shares of the newly minted preferred stock ARCPP.

We have 5699 shares of this stock "AMERICAN RLTY CAP 6.7PFD" ARCPP, in a trust with a total value of about $2M.

I'm trying to understand exactly what sort of animal this preferred stock is. Recall I'm pretty new to this, and trying to tackle the big moving parts first. This was a small part of the overall portfolio, and as of last fall when I started taking the reins in earnest, American Real Capital had some bad news and the stock tanked anyway. So we held on, and its now trading above 24.

From what I can gather, this is a Primary Preferred - "Preferred (6 7/10 % Cum Red Pfd Shs Series -F-)". It pays a dividend each quarter, and again from what I gather these types of shares have some bond-like characteristics.

This site seems to have the most info of any I have found:
https://www.preferredstockchannel.com/symbol/arcpp/

Questions:

Can anyone explain to me how this sort of instrument works - it seems very much like a bond in many ways, and like a stock in others.
Since I already have this in the portfolio, would it be prudent to keep it? The 6.7%/year dividend is not too shabby.
What is the "liquidation preference price" of $25 mean?
I see that it's callable in January 2019. What does that exactly mean to me?
Anything in particular about this asset strike anyone as "get out now while the getting is good" or "hold on, and reap that dividend"?

This asset is held in a family trust, which will be distributed over the next 8 years. The bulk of the assets in the trust are now invested boglehead style in a modified 3 fund portfolio (mimicking the lifestyle funds from VG). This trust is also heavy into private REITs still (cant get out of all of them yet). About 45% heavy.

Thoughts? Thanks-
satch
Posts: 31
Joined: Fri Feb 06, 2015 11:42 am

Re: Help me understand preferred stock we own...

Post by satch »

http://www.quantumonline.com/search.cfm
Go to the above and lookup ARCPP. It should provide some more information on the preferred stock and probably answers some of your questions below.

Here is another good site explaining what you are invested in.
http://www.dividenddetective.com/preferred_stocks.htm

I would move on to something else - If you want dividends, maybe a dividend ETF holding multiple dividend stocks, rather than this Preferred REIT taxed as ordinary income - but I would go with whatever the BH folks recommend.
Karamatsu
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Joined: Mon Oct 27, 2008 2:42 am

Re: Help me understand preferred stock we own...

Post by Karamatsu »

Well, I had this nice long note all written but then my session timed out and it vanished. The short answer is that you should read the prospectus, keeping in mind that it's a sales document, not an unbiased evaluation, and answer just this one question: If you had $2M in new cash to invest, would you buy these shares?

Given your commitment to an otherwise straightforward three-fund portfolio, I'll assume that the answer is, "No," so probably the best choice is to sell. The issue has hefty volume so the current price is probably a fair one given the inherent risks, which are significant, while there isn't a whole lot of upside.

But of course, I'm just an anonymous voice on the Internet, and you should make your own evaluation.
Luke Duke
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Location: Texas

Re: Help me understand preferred stock we own...

Post by Luke Duke »

Karamatsu wrote:Well, I had this nice long note all written but then my session timed out and it vanished. The short answer is that you should read the prospectus, keeping in mind that it's a sales document, not an unbiased evaluation, and answer just this one question: If you had $2M in new cash to invest, would you buy these shares?

Given your commitment to an otherwise straightforward three-fund portfolio, I'll assume that the answer is, "No," so probably the best choice is to sell. The issue has hefty volume so the current price is probably a fair one given the inherent risks, which are significant, while there isn't a whole lot of upside.

But of course, I'm just an anonymous voice on the Internet, and you should make your own evaluation.
She has $135K out of $2MM invested in the fund.
Karamatsu
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Joined: Mon Oct 27, 2008 2:42 am

Re: Help me understand preferred stock we own...

Post by Karamatsu »

Oh, OK. Much better, in fact. But in any case, the core question still stands. Is this something you'd buy for the trust with new money? If not, then unless there are side-effects like tax consequences, that's an excellent reason to sell.

The issue itself, well... essentially in exchange for your $135K they're agreeing to pay you $1.675 (6.70% of $25) per share per year. After five years they have the option of calling the issue if it's to their advantage to do so, in which case you'll receive $25/share plus any unpaid dividends. Essentially they'll force you to sell (liquidate) the holding, except it will all happen behind the scenes without any action on your part. Typically issues are called when the company can secure alternative debt financing at a lower interest rate, a bit like refinancing a mortgage. But since rates are quite low now, and the issue is trading below par, that's unlikely to happen. The more likely scenario is that rates rise, the price of the issue falls, and it is never called, in which case you're stuck forever (unlike a bond, there's no maturity date) with an issue paying below-market rates unless you sell at a loss, the company folds, or there is a change of control. The issue has some explicit caveats in case of change of control, which may mean they anticipate selling out and this is just a transition step. In that case the issue is structured to be of greatest benefit to the company, rather than to you. I have not read the prospectus, but since it makes a point of being cumulative, it looks like the company also reserves the right to suspend payment of dividends whenever they feel like it with no adverse effects on them (unlike when a bond defaults). This is pretty standard fare in the preferred stock world. The "cumulative" means that, if all goes well and the company doesn't go bankrupt, the unpaid dividends will be paid eventually, but that can take a long time (just how long will be in the prospectus). Meanwhile if the investment is taxable, you'll pay tax on the unpaid dividends as if they had been paid (phantom income). Speaking of tax, it pays ordinary dividends, rather than qualified, but I don't know if that's a problem with a trust. After five years, when the issue becomes callable, its market price will be capped at around $25 and change because of the call risk, so that's the upside limit. It's hard to evaluate whether the $1.675/year is a shabby yield or not because the issue isn't rated. Based on the current yield the market seems to be treating it as sitting on the border between investment grade and junk. The market price will be sensitive to interest rates so if rates rise, as everyone has been expecting for a long time, this is probably a good time to sell.

But the better reason to sell is the one at the top. It doesn't fit your portfolio design sufficiently well that, if you had $135K in new money, you'd buy these shares outright. Instead you'd probably just divide the cash among the three funds, right? So selling and buying shares of the three funds seems like the best choice.
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Pajamas
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Re: Help me understand preferred stock we own...

Post by Pajamas »

I bought some ARCPP for my retirement accounts when it dipped below $21 late last year, for the yield on cost of 8% and the expectation of some capital gains. I wish I had bought more now, but there was a cloud over the company at the time, so there was additional risk over what would be usual.

The best first source of information about particular preferreds is QuantumOnline.com, as you have already noted. Consider making a contribution to the owner if you use the site regularly.

This particular preferred pays dividends monthly rather than quarterly: $0.1395833 each month per share for an annual total of $1.675 per share. This monthly payment is unusual in the world of preferreds, but some REITs pay monthly dividends as some investors prefer a monthly payout.
Since I already have this in the portfolio, would it be prudent to keep it? The 6.7%/year dividend is not too shabby.
It's hard to do better than that fixed dividend and the resultant yield right now, all things considered. If they redeem it for $25, you would also get another $0.99 per share vs. selling it today, based on today's $24.01 closing price. That would put you at about 8% annual yield based on today's price. Of course, they may not call it then, or ever. It also is possible that it trades above $25 at some point.

It is relatively safe because the issuer holds real estate, although it has been under some turmoil lately, to say the least, as you are already aware. There has been a change of the disgraced management and some of the board members.

You can think of it as a bond for asset allocation for the most part, except that in the event of a bankruptcy liquidation, it is junior to bonds and senior to common stock in pecking order.

The only reason I personally would consider selling it is because 45% of the portfolio is already in REITs. This is a preferred stock, but it is still in the sector and susceptible to the same risks. Of course, you wouldn't buy it now because it doesn't fit your plan, as someone pointed out, and that may be reason enough to sell it.
What is the "liquidation preference price" of $25 mean?
I see that it's callable in January 2019. What does that exactly mean to me?
They can "call it in" or redeem it beginning January 2019, which means they can force you to sell it to them at any time after 1/3/19. They would have to pay $25 plus whatever unpaid dividend has accumulated up to the date of redemption. Your broker would handle the transaction automatically. The shares would be removed from your account and replaced with the cash on that date. It is treated as a sale for all purposes that I can think of, including for taxes.
Topic Author
jbrinker
Posts: 68
Joined: Wed Sep 24, 2014 1:33 pm

Re: Help me understand preferred stock we own...

Post by jbrinker »

Thank you everyone for the replies. Sorry to check back in after so long - I was following the replies and then life and work intervened.

So, based on what everyone here has said, and what I have been able to gather so far, my thoughts are:

- The trust received this stock as part of the wind up of a prior ARC private REIT. Part was redeemed in cash, part in this preferred stock. My initial plan was to liquidate this at the first reasonable opportunity, and in fact had a meeting already scheduled with new FA and then it took a huge dump late last fall. So we decided to sit it out and wait, under my impression that the problems at AR were not structural, and that it would likely recover. It has, to nearly par ($25). I said at that time that if it recovered to $24+ that we would sell.

- Now that it has, and I have tried to read more into what it is (sell decision was partly based on "If you do not understand it, you have no business owning it") I feel I do understand it better.

- The negatives as I see it are: 1) this account is totally taxable. The dividend is taxed as ordinary income. 2) Already very heavy in private REITS, looking to get out of them as it becomes possible. This just tilts toward the same sector. 3) If I want to get, get now while the gettin's good. 4) does not fit with investment plan for this trust.

- Positives: Pays a healthy div, monthly. 2) Company looks to have survived the shake-up, and likely come out the other end in better shape.

Seems to me I have made up my mind, and it would be wise to simply liquidate this now while it's a good time to do so.

Mostly concerned that I have missed something, but you all seem to generally agree. Thanks for the help.
Tanelorn
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Re: Help me understand preferred stock we own...

Post by Tanelorn »

This one was cheaper when the company was more distressed and it was trading at 20% below par. Now it's basically a bet on interest rates not rising - 7% yield is pretty good for a well capitalized company. The fixed rate means you'll do worse, either in terms of opportunity cost or declining market price, if interest rates meaningfully rise. That said, I think that's unlikely, so I would keep it but that's your call.

As a preferred, I don't really lump it in with REIT exposure as much as more like a bond. If it were a shaky energy company preferred, well, those are a lot more like equity when the company future is in doubt.
SHB
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Re: Help me understand preferred stock we own...

Post by SHB »

Take it for what its worth but I do acquisitions underwriting for a large real estate company and have just a couple thoughts. First, the private REIT industry is, generally, best avoided by laymen. The structure most used for non-traded reits is ripe for abuse by managers and very opaque. Second, specifically for ARCP, I would be very surprised if ARC can keep that dividend up in the future. The properties they invest in have little residual value and given their recent history fund raising for future acquisitions is going to be a concern. At a current yield of 7.05% you are certainly getting paid for it though.

That's just my 2 cents.
Tanelorn
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Re: Help me understand preferred stock we own...

Post by Tanelorn »

SHB - are you talking about the common dividend or the preferred dividend on ARCP not being sustainable?
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