LANDO - Gladstone Land: Series B Preferreds Provide A Highly Tax-Advantaged 8.1% Yield

2023-11-23 02:33:46 ET

Summary

• Investors are concerned about extreme interest rate volatility, geopolitical tensions, and dysfunction in the US Congress.
• Gladstone Land Corporation is an equity REIT that owns a diverse portfolio of farms and has steady growth in FFO/share.
• The company's preferred shares, particularly LANDO, offer a high yield and potential tax advantages for investors.

Extreme interest rate volatility, mounting geopolitical tensions, and continuing dysfunction in the U.S. Congress were among the many worries that sent investors to the sidelines throughout the 3rd quarter and into October. Such protracted uncertainty, combined with liquidity constraints, almost always results in asset price dislocation. Examples abound, but today we will focus on an equity REIT preferred supported by $1.6B of productive American farmland: Gladstone Land Corporation 6.00% Series B Cumulative Redeemable Preferred (LANDO).

The Issuer

Gladstone Land Corporation ( LAND ) is a $1.5B enterprise value equity REIT that owns a geographically diverse portfolio of 169 farms that in turn produce grains, fruits, fresh produce, tree nuts, and wine grapes. Feeding the world enjoys sustaining, strong demand and that has helped LAND to steadily grow its FFO/share. The assets and operations are strong; the preferred share prices are significantly dislocated.

The company is currently obliged to about $550MM fixed rate debt that carries a weighted average interest rate of 3.34% and an average maturity of 4.6 years. The rapid rise in interest rates has not posed an immediate risk for the company.

Because we are equity investors, our only concern here is that a company's debt load is manageable, which LAND's is. We want to investigate the rest of the capital stack, and this is how it breaks out.

The preferreds (LANDM, LANDO, LANDP) are $25 liquidation preference equities that are inferior to the debt, but superior to the common in the equity stack. LANDM carries a 5.0% coupon and a scheduled mandatory redemption of 01/31/2026. LANDO and LANDP carry 6.0% coupons and are essentially pari passu in structure and rights. We are today focusing on LANDO because, in addition to a fat 8%+ yield available at today's market prices, its longer tenure is more illustrative of the tax advantages of its dividend (LANDO has been trading since 2020, LANDP only began trading in 2023).

LANDO's monthly $0.125/share dividend ($1.50/annum) translates to a nominal yield of 8.10% yield as measured against a current $18.50 share price. An apples-to-apples comparison of yield to other fixed income investment options, like Treasury notes or corporate debt, puts LANDO 200 to 300 basis points ahead. For taxable investment accounts, however, LANDO's structure as a REIT equity offers a potentially higher after-tax net return.

As the table above describes, starting in 2020 a growing portion of the dividend has been characterized as a return of capital. For top tax bracket payers, this treatment translated to a net after-tax 2022 distribution of $1.35/share on a current year consideration. The same $1.50 Qualified Dividend would be just $1.20 after-tax.

On Portfolio Income Solutions we maintain a spreadsheet with dividend tax characterizations for over 100 REIT common and preferred stocks.

Depreciation and amortization charges make this a typical tax advantage for equity REIT shareholders, but farm land is not depreciable, so we asked LAND, "What gives?". Catherine Gerkis, Director of Investor Relations at the Gladstone Companies, was quick to reply:

Most investors don't think that a farmland REIT would have much in terms of depreciation, and while we don't have as much as most commercial REITs, we have a lot more than many may realize due to the following:

• Almost all our farms are irrigated (due to the types of crops grown on our farms), so we have the irrigation infrastructure, and
• Several years ago, we started buying a lot more permanent crop farms (pistachios, almonds, blueberries, vineyards, etc.) and these also get depreciated, usually over 15-50 years."

Good answer!

The Takeaway

Rising interest rates and persistent inflation have made managing the fixed income portion of investment portfolios a more rigorous task. Interest volatility and the relative illiquidity of small-cap preferred issues have created price dislocations and widened yield spreads.

Gladstone Land Corporation 6.00% Series B Cumulative Redeemable Preferred is supported by a modestly leveraged, $1.6B portfolio of income-producing farmland and, at $18.50/share, is trading at 35% upside to par with an 8.10% dividend yield, paid monthly. The tax advantages of the dividend make the fruit even sweeter.

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