In Trying Times, Think Preferred Stocks

In the REIT area, Duke Realty's (DRE Quote) 8.375% Preferred Series O (DRE-O) trades at $18, sporting a current yield of 11.6%. Duke is one of the largest, most diversified commercial office real estate operators with more than 142 million square feet of office and industrial properties in 25 cities, mostly in the eastern U.S. and Texas.

Considerable fear exists that commercial real estate prices will continue to weaken. Further aggravating Duke's current situation is its land holdings of 7,700 acres for 113 million square feet of future development. Raw land prices are very soft and considered to be a big liability right now. Nevertheless, as preferred stock investors, my firm's primary concern is the company's ability to continue to meet its dividend obligations.

On that score, we believe Duke Realty's broad and diverse portfolio (308 properties in bulk distribution, 241 suburban office properties and 57 service centers will provide it with extremely stable cash flows. In the 12 months ended June 30, tenant occupancy rose from 93% to almost 95% and operating income climbed 2% on same-store basis (not including new properties).

Duke's customers are major corporations (Northrop Grumman (NOC Quote), AT&T (T Quote), Lenovo, Citigroup (C Quote), Wal-Mart (WMT Quote) and Anheuser-Busch (BUD Quote)) that sign long-term leases. Duke Realty is not overly levered, with its debt-to-equity ratio at 50%.

However, amid the current credit crisis, all leveraged companies have reduced access to new credit, making long-term financing for projects in construction problematic. The high-yield index spread is more than 9% over U.S. Treasuries, which means that any new financing on existing projects could be very expensive. Nevertheless, I believe that barring a full-fledged economic disaster, Duke Realty will weather the current financial tsunami, and Duke preferred shareholders will realize very good returns. Should DRE-O be called in February 2013, the yield-to-call would be 15.7%.