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The housing market is on the rise again in the U.S. after the 2008 recession. Business sentiment is changing and people are investing more in equities, hoping to get a risk-free return. During these good times, real estate investment trusts (REITs) are hot as a means of investment. One such REIT, Newcastle Investment (NCT), is proving to be the icing on the cake. Investing in REITs are a great way to have short-term liquidity and, at the same time, get timely dividends. Newcastle has been providing consistent returns and keeping shareholders happy. Let's look at the stock and see why it is worth investing in.

Stock Performance

Traditionally, Newcastle focused on investing in commercial real estate debt. Last year, it diversified its offerings to residential real estate, and since then its stock price has doubled. Starting from the initial years, it has invested more than $1 billion to date with an objective of maximizing the difference between the yield on its investment and the cost of financing. If I consider the period from September 2011 until now, Newcastle has a stable growing dividend and witnessed a stock price appreciation of 140%. It is trading cheaply at $10.35, with a forward price-to-equity (P/E) ratio of 7. The thesis of undervaluation holds out by looking at the price-to-book (P/B) value of 1.69 compared to the REIT industry's 2.2. Newcastle's current dividend yield is 8.8%, which is one of the highest in the REIT industry.

Newcastle Spin-Off -- A Reason to Cheer for Investors

There has been news that Newcastle would be spinning off a new entity, under the ticker NRZ, with significant real estate holdings. It was scheduled to happen on Feb. 28, 2013, but has not been completed yet. The main purpose behind this split is to diversify its portfolio and mitigate some of its risk. NRZ is a portfolio that will invest in risky loans and high risk/return residential mortgages. Newcastle is more suited to the risk-averse investor and will be focusing on the stable business of commercial real estate loans.

Investors can decide which company to invest in depending on their appetite for risk. As per the Newcastle management, the combined dividend of the two companies is expected to be $1.06, which is a 20% jump from the current $0.88. That would mean substantial shareholder income from the new split. An increased dividend could also mean a higher yield, which would lead to stock price gains from the current $10.35 level.

Competition

Annaly Capital Management (NLY) manages a portfolio of mortgage-backed securities. Though it has a higher market cap than Newcastle at $14.81 billion, Annaly has not been performing up to par. The 52-week stock price change is negative at 3%, and there is no significant gain for investors. The dividend yield is impressive at 11.5%; however, the company reduced it in the last quarter. Annaly's main revenue stream comes from the Federal Reserve regulations. When the Fed lowers interest rates in times of high unemployment, Annaly gains from the increase in net interest margin. On the downside, during times of improved consumer sentiment and low unemployment, its business takes a hit due to higher interest rates.

Arbor Realty Trust (ABR) invests in multi-family and commercial real estate bridge loans. With a market cap of $231 million, it has a comparatively lower dividend yield of 6.6%. However, the company scored higher in terms of stock price returns, with its shares appreciating by 30.5% in the last one year. That beat the S&P 500 by a huge 17% margin. It is trading cheaply at $7, with a low forward P/E and P/B ratio. However, the EPS growth rate is not very high and the stock still remains a risky one for investors. It already experienced $5.7 million of losses in the fiscal year 2012 on sale and restructuring of loans. Unlike Newcastle, Arbor does not have any separate entity and holds a portfolio targeted to a fixed industry. Commercial real estate investments are subject to market volatility and Arbor, without any solid backup, could face the heat.

The Bottom Line

REITs are subject to various risks like market volatility and interest rate risk. Among all the REITs in the industry, I believe Newcastle to be the most adept one in managing risks. It effectively hedges by emphasizing portfolio management, asset quality, credit risk management, and diversification. Investors are looking forward to the spin-off of the new residential mortgage arm and gaining substantial returns. With a low forward P/E, good dividend yield, and expected increase in returns, Newcastle is surely set to reach new highs in the coming months.

Source: Newcastle - A Good REIT To Invest In