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Author: tjberko One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 77098  
Subject: Re: COR-A Buy Alert Date: 11/2/2013 4:28 PM
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It's interesting, XOT, that in the bond world there is such a large difference in yields based on safety (Moody's rankings). One electric utility might be rated A1 and another BAA3, and although they are both investment grade regulated utilities, and the difference in the chance of bankruptcy between the 2 utilites is negligible, there can be up to a 2% difference in their yields. And of course with Treasuries, a 10 year treasury yields just 2.6% while an investment grade 10 year corporate utility bond may yield 6%. In the bond world, it makes no sense to buy the highest rated bonds. The increase in yield that you get from taking just the slightest risk is so great that it is absurd. I only buy lower rated corporate bonds.

But in the preferred world, it is just the opposite. You get a very little extra yield for purchasing a preferred with a poor balance sheet versus what you get from a preferred with a solid balance sheet. It is quite difficult to understand the dichotomy between how investors treat bond risk and preferred stock risk. So in my preferred investing, I generally prefer to accept a slightly smaller yield in order to be in quality names. Compared to the very steep yield penalty you pay for buying high quality bonds, the penalty for buying high quality preferreds over the junk is miniscule; and it certainly paid off big during 2008 when REITs with poor balance sheets saw their preferred stocks fall into the mid to even low single digits.

Take the current example of ABR-A which closed at 25.15 for an 8.19% yield. ABR probably has the worst balance sheet in the REIT world (very high leverage), and additionally it is in the business of mezzanine financing which is a very risky sector. Then you have an REG-G with a 7.25% yield and a pristine balance sheet, in a safe REIT sector with a $20.70 price. For less than 1 percent yield difference, REG-G has a lot of upside while ABR-A has none, and if they were bonds, the ABR bond would have to yield 3 to 4% higher than the REG bond to get investors interested. But for some reason in the preferred world, the yield differential is small. CLNY-A, which is much safer than ABR-A, has an even higher yield than ABR-A at 8.38%. You are paid almost nothing, or even less than nothing to move down the quality curve in the REIT preferred world. I think it makes more sense to use your own leverage to juice up your yields rather than buy REITs who juice up their yields with high leverage. I will post on the topic of leverage shortly.
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