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Agency Mortgage REITs provide yield hungry investors access to strong dividend yields. These securities typically perform well in low interest rate environments with steep yield curves. We think they provide investors a hedge against heavy cash and short-term bond portfolios in the event interest rates stay low for an exceptionally long period of time.

Mortgage REIT Overview

Mortgage REITs take advantage of a tax status to invest in mortgage related real estate assets. REITs can invest in both physical real estate assets and real-estate related securities like mortgage backed securities (MBS). REITs electing the take advantage of the tax status must distribute 90% of taxable income as dividends. The primary advantage of using the REIT tax designation is that these companies do not pay state or federal corporate taxes on dividends paid to investors. Instead, the taxes are paid by the REIT equity holders (investors).

Tenure and Diversification

Given the risk to portfolios in volatile interest rate environments, we believe that investors should focus on those managers that have proven they have been able to weather multiple rate cycles. In addition, we think it is prudent to diversify mortgage REIT holdings as managers deploy different strategies within the complex.
Agency and bias toward Fixed Rate Mix
  • Annaly Capital Managment (NYSE:NLY)
  • American Capital Agency (NASDAQ:AGNC)
Agency and bias toward Floating Rate Mix
  • Anworth Mortgage Asset Corp. (NYSE:ANH)
  • Capstead Mortgage Corp. (NYSE:CMO)
  • Hatteras Financial Corp. (NYSE:HTS)
Current vs. Historical Valuation As shown in the table below, most agency mortgage REITs are currently trading at a significant discount to historical average price-to-book value.
(Click chart to enlarge) We believe that due to the structural headwinds in the U.S. economy, the Federal Reserve will remain on hold for an exceptionally long period of time. That said, we believe that current valuations are attractive for agency mortgage REITs.

Disclosure: I am long NLY, AGNC.

Source: Comparing Agency Mortgage REIT Valuations