Keep an Eye Out for Secondary Offerings Before Investing in Mortgage REITs

by: Zvi Bar

Real Estate Investment Trusts (“REITs”) must distribute at least 90% of their taxable income in order to eliminate the need to pay income tax at the corporate level. Because these REITs must give away so much income, they cannot grow through retaining and re-deploying earnings. As a result, many REITs often choose to place secondary offerings in order to raise capital and increase market valuation. Such actions can be either dilutive or accretive to actual share value, depending on how productive the REIT is at using the acquired funds.

Mortgage REITs are probably the type of REIT that most frequently offers shares through a secondary. These REITs manage portfolios of securitized mortgages. Mortgage REITs have become of interest to an expanding group of investors over that last few years for multiple reasons, but primarily due to the lofty yields that many mREITS offer and also due to the perceived limited risk within agency REITs.

Earlier this week, Annaly Capital Management, Inc. (NYSE:NLY), the largest of the mREITs, priced a secondary public offering of 120 million shares of its common stock, plus an option for 18 million more. This secondary was priced at $17.70 per share, and Annaly expects gross proceeds of approximately $2.1 billion before expenses and the options.

Secondary announcements invariably knock the price of these mREITs down. A secondary price is customarily set to a few percent below the present market valuation. Individuals that purchased shares in advance of such offerings are going to be upset, while those who were waiting for a better price may find that buying at or near the value of a highly demanded secondary probably represents a strong value.

Generally speaking, and assuming no other negative news, mREITs tend to be at their lowest prices either around such secondary offerings or following their ex-dividend dates. Many investors have postulated that the best time to buy into mREITs is at the latest possible time after the ex-div drop, but before the shares begin to again climb up in anticipation of the next dividend.

Another strong option might be to simply attempt to enter the mREIT at the new secondary price. Generally speaking, the move down off of a secondary offering for an mREIT is short-lived. Below are charts (click on each to enlarge) that indicate the occurrence of secondary offerings within 2011 for NLY and American Capital Agency Corp. (NASDAQ:AGNC), the two largest mREITs. Both have announced 3 secondaries within 2011, which are identified by the red arrows (dividend payouts are noted by the red arrows).

NLY 2001 Performance with Secondaries:

AGNC 2001 Performance with Secondaries:

While these arrows do not always point to the lowest possible prices, they do clearly point out lower than average prices, and better than average entry points. Many new buyers of these two popular REITs would probably be happy to have paid the average price delineated by these points.

Other large mREITs include Anworth Mortgage Asset Corp. (NYSE:ANH), Capstead Mortgage Corp. (NYSE:CMO), Hatteras Financial Corp. (NYSE:HTS) Chimera Investment Management (NYSE:CIM) and MFA Financial (NYSE:MFA). Most of these companies use secondary offerings on a somewhat regular basis, though exceptions do exist. For example, CIM enacted a new standing program where the management may sell new shares into the daily market at whatever the market price is at that time. Nonetheless, CIM may still later engage again in secondary offerings and most of these companies still adhere to a strict and habitual regimen of secondary offerings that is likely to continue for the foreseeable future.

By looking out for announcements on secondary offerings, individual investors can buy these high yield companies with the knowledge that institutional money and advised high net-worth investors are buying in at the same prices.

Further, do note that the dividends these REITs produce are taxed as ordinary, and not at the normal dividend rate. Many income investors hold such income investments in tax-sheltered accounts like an IRA. In a tax-sheltered account the higher tax-rate is less of a concern.

Disclosure: I am long NLY, CIM

Disclaimer: This article should not be construed as personalized investment advice as it does not take into account your specific situation or objectives.