Some investors stay away from REITs and have concern about their high yield dividends, but the long term outlook with extremely low borrowing rates is making them a compelling play. Choosing a REIT to invest in can be a difficult task as growth can often be hard to gauge and dividends can change with performance which often varies according to the type of investments the firm makes. REITs often specialize in government or agency-backed mortgages, non-agency-backed mortgages or a combination of both (hybrid).
The current positive operating environment for most REITs is a product of quantitative easing by the Fed, the low borrowing rates that the government has promised for the future, and property values that have for the most part stabilized. Most REITs deal with government-backed securities that might not have the higher interest rates of bank loans, but allow the REIT to operate without the high risk of default that banks have to deal with. The margins are low, but with borrowing rates also low and the risk of these securities negligible, these firms are able to borrow five or six times as much as the actual capital that they have and realize a greater margin on the initial investment. This helps effectively increase their overall return and makes them highly efficient as long as interest rates are kept low and the housing market is stable. Sounds too good to be true, or is there a catch?
Some investors look at REITs and consider them to be about as attractive as a ponzi scheme, but these companies are scrutinized by the government. They are able to return high yielding dividends mostly because of the 90%/10% rule that allows a REIT to be exempt from federal income tax if at least 90% of its profits are returned to investors. Thus, the high dividends are built into the performance of the REIT and the ability of the REIT to make money. Stock prices of most REITs do not fluctuate too wildly and the performance of the shares depends on the breakdown of securities that the firm holds. The only threats to a REIT is with any events that act to shrink the spread of interest rates they operate with.
If the interest rates stay low and banks start lowering lending rates because of lower default rates, the securities that REIT's typically buy come with lower margins between lending rates and borrowing rates leading to less profit. If interest rates start going up, it also puts a squeeze on the margin between the interest rates a REIT can borrow money at and the rates of the distressed securities a REIT can buy. In either case, the spread can become too thin. This trims profits and hampers growth as the interest rate of loans on the REIT's books can in some cases start to become lower than the current borrowing rate in extreme cases. As the economy sputters and inflation remains in check, REITs have become less of a risk as long as the housing market has started to recover and banks continue to lend money at much higher rates than the prime lending rate. This gives a REIT nice margins and good prospects for growth.
There are other positives about investing in a REIT. As far as operations are concerned, they operate with very little overhead requiring a minimal amount of employees, a modest lease and very few additional expenses. The government backing of most securities that power a REIT's portfolio is a big risk reducer and the fact that about 90% of current home mortgages are backed by the U.S. government also helps. Many REITs are hybrid REITs with the safety of government-backed securities coupled with the bigger margins of non-agency-backed securities. The big question with most of them now is how high the shares can go and what time is right to jump in. The following six REIT's are all pretty solid investment opportunities and the current dividend yields are hard to come by.
New York Mortgage Trust (NASDAQ:NYMT)
$7.20 / share (52-week: high - $7.69 / low - $5.51)
6.66 P/E ratio
15% dividend yield
NYMT is a hybrid REIT with investments in government-backed securities comprising about 60% of its loans. It also has CMBS and other distressed mortgage-backed securities and related assets.
American Capital Agency Corp (NASDAQ:AGNC)
$31.80 / share (52-week: high - $36.77 / low - $28.08)
7.63 P/E ratio
15.7% dividend yield
AGNC is a REIT involved with exclusively government-backed residential mortgages. It is one of the bigger REITs with a market cap of $10.78 billion.
Two Harbors (NYSE:TWO)
$11.69 / share (52-week: high - $13.05 / low - $9.17)
9.75 P/E ratio
10.90% dividend yield
TWO is a hybrid REIT with about 80% government-backed mortgage securities. Has a relatively high 2.9% spread and has a market cap just under $3.5 million.
Annaly Capital Management (NYSE:NLY)
- $15.64 / share (52-week: high - $17.75 / low - $13.72)
9.12 P/E ratio
11.5% dividend yield
NLY is involved with primarily government-backed residential mortgages and operates with a very low spread of about 1%. It's driven by revenue and volume and a market uptick will only help with Annaly's growth. It has a big market cap of $14.81 billion.
MFA Financial (NYSE:MFA)
$8.98 / share (52-week: high - $9.59 / low - $7.23)
10.78 P/E ratio
9.80% dividend yield
MFA is a hybrid REIT with a mixture of government-backed and non-agency securities. It has a market cap of $3.22 billion and has been coming off its high of $9.59 a share experienced in March.
Chimera Investment Corp (NYSE:CIM)
3.16 / share (52-week: high - $3.34 / low $1.81)
24.31 P/E ratio
11.4% dividend yield
CIM is a hybrid REIT with a mixture of various residential and commercial securities. Its stock has been rising this year as the price has exceeded its 1-year target and its market cap has become $3.25 billion in the process.
The outlook for these mortgage REITs remains pretty good when compared to other companies paying similar dividends. The mortgage industry is starting to rebound in many areas and this rebound will lead to higher revenues simply by the increase in housing prices alone. The big fear for many mortgage-backed securities is the bubble that has developed as these companies have assets that have quadrupled since 2009 and seem to keep acquiring more. The Fed is worried that this bubble with paper securities can develop in much the same way as the housing bubble did and then ultimately face the same consequences. Although this might be extreme, more regulations might come to this sector in the future and possibly take away some of the ability to realize these current profits. However, the dividends that can be realized right now are too good to come without some kind of risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.