GOCMEN/iStock via Getty Images There is just something about the way mREITs operate that continually makes preferreds a better tranche than common. Two Harbors Investment Corp. ( NYSE: TWO ) epitomizes this concept as the preferreds flourish while the common has suffered.
Over the past five years, Two Harbors common has returned negative 50% while its preferreds each returned +37% to +45% S&P Global Market Intelligence This article will discuss the structural and mechanical reasons the preferreds so drastically outperformed the common. We believe preferreds of mortgage REITs will continue to outperform their common counterparts and TWO preferreds, in particular, will continue to be the better tranche. Let's begin with the structural aspects of mREITs that favor preferreds.
Structural aspects of mREITs that favor preferreds REIT rule requires to pay out 90% of taxable income. No real estate depreciation to shelter income. Preferred dividend priority.
Low-risk assets with capped upside. Damage is routinely one-time in nature. Issuance of common shares to rebuild cushion.
REITs get the substantial benefit of not having to pay corporate income tax which allows them to avoid the double taxation most other companies suffer where the company is taxed and then the investor is taxed again. To get this benefit, REITs have to pay out at least 90% of their taxable income as dividends to investors which makes them a pass-through entity. This 90% rule applies to both equity REITs and mortg.
