LAND - Gladstone Land: The Preferred Shares Offer An Excellent Risk/Reward Ratio

2023-03-28 10:30:00 ET

Summary

• Gladstone Land is a farmland REIT. I like this segment of the real estate sector.
• The preferred shares are an important part of the capital structure as it provides attractive returns to investors while it is a cheap source of capital for the REIT.
• The LANDO preferred shares offer a 6.8% yield. The LANDM preferred shares are also attractive but can be called in 2026.

Introduction

I have recently been on the lookout to add to existing positions of preferred shares and perhaps to add a few new names to my portfolio. Gladstone Land (LAND) has two interesting series of preferred shares which were never really cheap (from my perspective as an European who is subject to the US withholding tax on preferred dividends), but the evens on the financial markets in the past few weeks have changed things.

A look at the FY 2022 results from the perspective of a preferred shareholder

The business model of Gladstone Land is very straightforward: the REIT owns farmland and leases it to farmers. It is not exposed to successful or disappointing harvests other than the impact it has on the tenants. As of the end of 2022, Gladstone Land owned in excess of 115,000 acres of farmland across 15 states and divided over almost 170 farms .

When I look at the preferred stock of a REIT, I always want to make sure the preferred dividends are well covered. This determination should not be based on the reported net income (as this takes the depreciation of the farm land properties into account) but on the ability to generate a positive FFO and AFFO on the assets. The image below shows the AFFO calculation attributable to Gladstone Land's common stockholders.

The total AFFO was $24.8M but as you can see in the image above, this includes the $19.7M in preferred dividend payments. This means the total AFFO before making the preferred dividend payments was approximately $44.5M and the company needed 44% of the pre-dividend AFFO to cover the preferred dividends.

However, investors should realize the REIT has sharply increased the total amount of Series C preferred shares that are currently outstanding. The balance was just 3.5 million preferred shares as of the end of 2021 but this increased to 10.2M shares as of the end of 2022. The C-series are not listed, only the B-series are. Both series of preferred shares have the same preferred dividend of $1.5 per year which means the current annualized rate of the preferred dividend (based on the year end share count in 2022) will increase to $24M this year.

This does not necessarily have to be a huge issue as Gladstone Land is obviously using the proceeds from the increased preferred share count to invest in new assets. And just as a side note, the REIT also has a term preferred share issued (the preferred shares D) but as these have a (pro forma) end date in 2026, Gladstone Land is allowed to expense those preferred dividends as they are 'interest-like' due to the mandatory call in 2026. Gladstone Land could defer that call but will have to pay a penalty as a non-call in 2026 will increase the preferred dividend to $2/share. But the D-series fall outside the scope of this article.

The fair value of the assets is higher than the book value - this provides an additional safety net

Instead, I would like to focus on the B-Series of the preferred shares, which are trading with (LANDO) as ticker symbol. The terms of this preferred share are very straightforward: the owner will receive $1.50 in preferred dividends on an annual basis, divided in four equal quarterly dividends of $0.375. These preferred shares can be called at any time but given the low cost of equity, I doubt Gladstone Land will call these securities anytime soon. On the contrary: as this is a cheap source of capital, Gladstone has issued additional preferred shares in 2022 so the 'risk' of the preferreds being called appears to be low and I will not factor this in.

As LANDO is currently trading at just $22/share, the yield currently exceeds 6.8% which I think offers a pretty nice risk/reward ratio. In the previous section of this article I already discussed the coverage ratio of the preferred dividend, but it is also important to have a look at the balance sheet to see how much common equity ranks junior to the preferred shares.

As of the end of 2022, the total equity stood at just over $731M (and as you notice, the series D preferred shares are listed as a liability rather than equity because it has a mandatory call date). As there are 16.15 million preferred shares outstanding, the total value of those preferred shares is just over $400M. This means that based on the balance sheet there is approximately $331M in common equity ranking junior to the preferred shares.

That's not a great ratio as this means the asset coverage ratio is just over 180% and that for sure is on the lower end of the spectrum.

There is however a pretty sizeable difference between the book value of the farmland assets (which already includes a cumulative depreciation of almost $107M) and the market value of the farmland. A recent appraisal indicated the fair value of the real estate assets of $1.57B.

This indicates there is about $245M in 'hidden value' on the balance sheet: the difference between the fair value of the assets and the book value. This additional value is attributable to the common stockholders which means the adjusted equity value on the balance sheet would be $977M and result in a much healthier asset coverage ratio of 242%.

Investment thesis

I like farmland and I think the preferred shares issued by Gladstone Land are an excellent way to have some exposure to this very interesting subsector of the real estate market. Investors speculating on capital gains could stick with the common shares, but investors looking for a reliable income stream may be very interested in Gladstone Land's preferred shares.

I currently have no position in any of the Gladstone Land vehicles, but I would be interested in buying both the B-Series and D-Series of the preferred shares.

For further details see: