One Bulletproof REIT in the Midst of the Real Estate Mess

by Robert Williams

The U.S. housing market is walking the plank. Easy credit helped usher in an unprecedented period of rising home prices. But now those same lax credit standards have us caught in one of the worst slumps in recent memory.

According to the latest data, the inventory of unsold homes sits at 4.23 million, representing a 10.2-month supply at the current sales pace. For comparison’s sake, that’s as many homes as Delaware, North Dakota, South Dakota, Alaska, Vermont and Wyoming have people. In other words, an eager buyer these days is about as hard to find as a living dinosaur.

But before you abandon the beleaguered real estate sector altogether, you should know that opportunities for safe and steady profits do exist. In fact, I’ve found a handful that may well be the most attractive investments - given the abysmal state of the markets right now - this side of the credit crunch.

Investments That Pay Stock Dividends Like Clockwork

These investments all pay handsome stock dividends like clockwork. And they avoid the volatility swings that now define the stock market, too. What an enviable tandem to have in your portfolio as we embark on what could be another tumultuous year for stocks.

Even better, when the market rights itself - and the inevitable real estate recovery occurs - you’ll be perfectly positioned for a nice pop in the stock price, as well. (That’s right: You’ll own shares that trade on major stock exchanges, not the properties themselves.)

So as the credit crunch bites off more market capitalization nearly every day (we’ve already witnessed $28 trillion in wealth disintegrate before our eyes), the following REIT (real estate investment trust) has enjoyed a bulletproof status of sorts.

One REIT That Works In the Face of the Credit Crisis

Let’s take a look and examine exactly why this REIT is working in the face of the credit crisis.

First Trust/FIDAC Mortgage Income Fund (FMY) invests exclusively in mortgages. The fund holds $100 million in mortgage-backed securities, the income from which allows it to pay a handsome 8% dividend yield. Now I realize that your instincts may be to skip to the next article after reading “mortgage-backed securities,” but before you do, understand that the fund didn’t lose a penny in 2008 and raised its dividend three times.

To understand how it pulled off this feat, you first have to know a little bit about the market for the securities the fund owns.

You see, the problem with mortgage-backed securities is that once it was discovered that many were backed by bad subprime mortgages, the market for trading them froze up. Thus, trading for the worst securities went “no bid,” which means there were no offers to buy. Using mark-to-market accounting methods, holders were forced to write down values to zero.

But First Trust’s net asset value declined only about 15% over the course of the year, which means the mortgage bonds it holds are the few still being actively traded through this credit crisis.

Dividend aside, there’s a capital appreciation component here, too.

When the day comes where mortgage-backed securities are in favor again (and it will happen), this fund’s share price will surge. So look past the bad apples and focus on the bulletproof.

Comments

[Lightway:]

NLY is another solid REIT pick, with great dividends, and holds a tremendous amount of holdings in Federally guaranteed Freddie Mae/Fannie Mac mortgages, making them a safe bet. I don't see much upside in capital appreciation, but a nice steady hold worth getting for the steady yield.

Disclosure: Long NLY

Jan 09 07:03 AM

[Schneidehouse:]

Can you please explain your math to arrive at 8%?

Jan 09 09:20 AM

[Schneidehouse:]

My apologies - I looked at the dividend as a quarterly number instead of a monthly number.

Jan 09 09:40 AM

[prairiedog555:]

I worry about the coming wave of mortgage refi's. Does that not hurt their portfolio and profits?

Jan 09 10:55 AM

[nobull:]

Good one!
However I am curious about what kind of adverse effects the dumb*** plan to modify mortgages by bankruptcy judges will have. You could have many healthy borrowers look at defaulting as a way to get rid of potential losses on their properties.

Jan 09 10:56 AM

[AEG:]

Looks like a yield of less than 4%?
Better off buying DVY at 5% plus no leverage

Jan 09 05:40 PM

[tamarak:]

Always interested in underappreciated investment opportunities. FMY, however, appears risky to me. It is a closed end fund, not a REIT. Its market value is only $67 million. The yield is attractive, but the expense ratio is high (3.24%). Currently it trades for a small premium relative to its value (1.42%, closed-endfunds.com). For comparison, 3 mortgage securities REITs with more readily evaluated financial information are AGNC, HTS, and NLY (e.g., MSN StockScouter ratings 10, 9, and 8 respectively). The yields are 23.0%, 15.2%, and 12.6% respectively. The 9 billion market value of NLY is much larger than the others. The prices of all 3 have appreciated approximately 40% in the past 3 months (October low). I own AGNC despite its short track record, having been IPO'd in May 08 (seekingalpha.com/artic...). AGNC was analyzed in a seekingalpha article and comments in September (seekingalpha.com/artic...). You bets your money, you takes your chances. Seems like there are better mortgage bets than FMY, but thanks for making me reconsider my choice.

Jan 10 11:52 AM

[Crocodilian:]

Salient difference between FMY and NLY, AGNC, HTS:

FMY is not leveraged. The other firms mentioned (and NLY and FMY share the same management), all have a lot of leverage (between 5 and 8 : 1); given the dislocations in the financial markets, there's been some concern about any model which relies on funding short to lend long, even if the proceeds are invested in (now) Government guaranteed Agencies.

So FMY _should_ yield less than the others mentioned. . . without the leverage, it earns less, and without the leverage, it takes less risk (probably).

By my lights, AGNC & NLY are better choices (especially with the spreads they enjoy), but FMY does have these differences which may make it a safer investment.

Jan 14 02:53 AM

[Just Say Whoa!:]

>FMY is not leveraged.

No leverage risk?

Not according to FMY:
finance.yahoo.com/news...

"Principal Risk Factors: Investment in this Fund involves investment and market risk, management risk, credit risk, prepayment risk, reinvestment risk, interest rate risk, floating rate CMOs and inverse floating rate CMOs risk, bond market risk, economic sector risk, inflation risk, U.S. government securities risk, government agency risk, asset-backed securities risk, market discount risk, leverage risk, interest rate transactions risk, derivatives risk, market disruption risk, portfolio turnover risk, tax risk relating to investments in certain REMICs, and illiquid/restricted securities risk."

Feb 26 02:52 PM