Better Real Estate Investing: 4 High Yield REITs (For the Short- to Medium-Term)

Includes: ANH, CIM, CYS, NYMT
by: Nicholas Pardini

Real estate has been struggling since the housing bubble popped in 2007. Home prices are not expected to rise significantly in the future, and rents (assuming 100% occupancy) often fail to yield more than high dividend paying stocks. Also the housing market is illiquid and highly leveraged. However, all of this does not mean that there is no money to be made in the sector.

Instead of flipping property, try trading off some high yield REITs. Four of the leading high yield REITs, Cypress Sharpridge Investments (CYS: 18.84% dividend yield), Chimeria Investment Management (CIM: 14.62%), Anworth Mortgage Corporation (ANH: 13.63%), and the New York Mortgage Trust (NYMT: 10.21%) all offer upward of 10% yields. They are a good hedge for commodity bulls and inflationists as these securities thrive when interest rates stay low. Unlike actually buying a house, there is no need to leverage onesself, and an investor can sell a REIT whenever he or she desires.

These securities sound a little too good to be true. What are the risks associated with buying one of these REITs? Essentially, these companies make money off the spread of borrowing cheap money through repurchase agreements with large banks affiliated with the Fed and then use the leverage to buy heavily discounted mortgage back securities.

The spread between them is what they pay out as dividends to investors. Currently this spread is extremely high due to near all-time low interest rates, and the fear of toxic debt has beaten down the price of MBSs far below par value.

The danger with these is that both yields and the price of these stocks are very sensitive to interest rates. When interest rates rise, the spread between the MBSs and the borrowing rate narrows. As a result, yields will fall along with the price of the securities, as high yield investors will sell for better alternatives. By buying a high yield REIT, investors are betting against interest rate hikes.

Overall, I recommend buying some of these REITs (up to 5% of your portfolio) in order to gain a high yield and as a protective hedge against investments based on the rise of inflation and/or interest rates. This recommendation is for the short to medium term (3-18 months) because once the Federal Reserve raises the Fed funds rate, both the price and the yield of these REITs will tank.

Sell these as soon as you hear about any legitimate concern about raising rates in the near term. Currently I hold CYS because it has the highest yield of all of these REITs without a significant difference in risk. I expect because of political reasons, rates will not rise until November 2012, shortly after election day. Until then, hold onto these things and get a few 2.5%-5% quarterly checks from your investment.

Disclosure: I am long CYS.

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