Gladstone Commercial Preferred G (GSCCP): Yield Arbitrage In Capital Stack

In regular occasions, the calendar 4th quarter is a time for traders to reap tax losses by promoting shares for losses that may wash realized capital positive aspects from different points. In our inflation combating, quickly rising rates of interest, excessive anxiousness 4th quarter 2022, issues appear extra advanced than regular which can have contributed to each funding peril and alternative. For example, we are going to have a look at the buying and selling in Gladstone Business (GOOD) equities and Gladstone Business Collection G most well-liked (NASDAQ:GOODO), particularly.

GOOD has been a strong month-to-month dividend producer since its IPO in 2003. We did not actually get entangled with GOOD till after the monetary disaster when its outsized dividend yield made it stand out amongst different triple internet REITS. In 2012, after CEO David Gladstone identified the tax advantages of that top month-to-month dividend, GOOD grew to become a staple in our taxable portfolios.

It has been a tricky yr for REITs normally, however by the top of September GOOD shares had been almost in freefall. Nothing uncommon was occurring with Gladstone Business on an operational foundation, we suspect it was simply REIT traders desirous to rapidly get to money within the absence of anybody wanting to purchase their shares.

Luckily, by early November GOOD regained some footing and in December has once more traded above $19.00. The anomalous and fascinating exercise, nevertheless, has not been within the Gladstone frequent, however in its most well-liked shares.

The Capital Stack

Over time, Gladstone has gone to the capital markets with many sequence of most well-liked share choices that they redeemed with proceeds from follow-on choices of decrease coupon preferreds. In the present day, solely the 6.625% Collection E (GOODN) and the 6.00% Collection G (GOODO) stay excellent.

During the last 52 weeks, each GOODN and GOODO traded above their $25 par values ($27+ every), however that premium began to fade concerning the time the Fed began climbing rates of interest. In late October, a real dislocation between patrons and sellers opened up on larger than regular quantity and each most well-liked points skilled double digit value declines.

The dislocation continues at the moment.

So, What’s Taking place?

It’s arduous to pinpoint what is likely to be motivating traders to promote their shares. It is likely to be a basic anxiousness and a want to get to money, get to the sidelines. Since it’s the shut of the yr, it is likely to be a necessity to reap losses in an investor’s tax planning. What’s unusual, and what the SA chart illustrates beneath, is that the frequent shares and the popular shares are buying and selling disparately throughout the calendar. The frequent shares cratered in September, however the popular shares did not actually disintegrate till the top of October they usually haven’t but stabilized. To the intrepid, this would possibly seem like a chance to enhance yield from the identical issuer.

Yield Arbitrage inside the Capital Stack

If we look at the dividend schedules for every of the three Gladstone equities, the yield benefits of the preferreds at present market pricing are apparent.

The opposite putting issue is GOODO’s 37% upside to name; if the Fed defeats inflation and we return to the idyllic, post-pandemic economic system of early 2021, perhaps GOODO can commerce at par once more and ship capital appreciation together with superior yield.

Dividends from the Similar Issuer are Largely Fungible. Why Not Get Extra?

It might sound an apparent alternative for a holder of GOOD to swap shares for the superior yield and appreciation potential of GOODO, however for taxable accounts the choice is a little bit subtler than that. In my July report detailing GOOD’s vital tax benefits, I described that 71% of the frequent’s 2021 dividend was characterised as a return of capital (taxation is deferred till shares are bought). That interprets to a a lot larger after-tax, carrying yield for GOOD vs. GOODO as a result of GOODO’s dividend is characterised as odd dividend earnings (taxable presently).

Our Trades

If we held GOOD in IRA/tax sheltered accounts, we swapped the shares for GOODO or GOODN. We improved the present yield by 40 foundation factors and might wait to see if the markets ship capital appreciation in 2023. For taxable accounts, we might proceed to carry the frequent and acquire the regular, tax advantaged month-to-month dividends.