Some income investors are so jittery that they don't want to risk their money in stocks, are almost as concerned about corporate bonds, and even want to avoid state and local municipal bonds. There isn't much left, except bank CD's and United States Government backed bonds. Thirty year Treasury bonds yield less than 4%, and you are lucky to get 1.5% on a CD.
However, there is one type of income investment that is gaining favor with income investors, and that is the government guaranteed mortgage real estate investment trusts. These REITs purchase residential mortgage pass-through securities which are guaranteed by government-sponsored entities, and use leverage to increase the yield. An example is Capstead Mortgage Corp. (NYSE:CMO), which generates a yield of 9.4%.
Capstone is a Dallas, Texas based REIT that has been around since 1985, and has paid quarterly dividends since 1987. The company invests in adjustable-rate mortgage securities issued and guaranteed by government-sponsored entities, either Fannie Mae (OTCQB:FNMA) or Freddie Mac (OTCQB:FMCC), or by Ginnie Mae, an agency of the federal government. Technically, with the explicit and implicit guarantees of the U. S. Government, the securities in the portfolio have an implied AAA credit rating. Although after what happened to the rating agencies and many of the companies and securities that they rated as triple A, I'm not sure that AAA means as much.
However, that is probably the biggest risk of this type of investment. Will the government entities, and behind them, the US Government, continue to guarantee the timely payment of principal and interest payments on these mortgages (with an emphasis on the word 'timely')? Assuming the government does come through, then a major risk of this type of investment is eliminated.
What about the risk of rising interest rates? Remember, when interest rates rise, bonds drop in value. Hopefully, the fact that Capstead invests in adjustable rate mortgages, as opposed to fixed rate mortgages, will help to alleviate that risk. But there is always the risk of a sharp increase in rates causing the REIT to drop somewhat.
Capstead has a current price to earnings ratio of 9 and trades at 7.5 times forward earnings. Although heavily in debt to increase the payout, the company does have $3.82 in cash per share. The price per share is about 7% below the book value of 11.87. The third quarter 2010 earnings conference call will be held October 28, 2010 at 9:00 AM Eastern time.
For more high yield REITs, check out the free list at WallStreetNewsNetwork.com, which can be downloaded, sorted, and added to.
Disclosure: Author does not own the above.