Mr. Market Trips on Mark to Market, Gives REITs Away

In this bountiful era of REIT wreckage, with liquidity having virtually disappeared from the mortgage market, the auction rate securities market, and last week, even the municipal bond market, it is helpful to be reminded of the irrationality that can sometimes rule daily trading gyrations.

According to Warren Buffett, Ben Graham, (the original legendary value investor and long time Buffett mentor) said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

At times he feels euphoric. When in that mood, he sets a very high price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead. On these occasions he will set a very low price, since he is terrified that you will try to unload your interest on him, bringing him immediate losses.

Mr. Market has another endearing characteristic: He doesn't mind being ignored. Consequently, Graham said, you must heed one warning: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful.

In my opinion, Mr. Market - always fallible and never perfect - is now being blind-sided by mark to market accounting. The non-cash charges resulting from these “mark to market” write downs are causing our servant Mr. Market to see nothing but trouble ahead for business and the world. Thus, he is setting a very low price, and that is creating opportunities.

In a different post, I will add more fascinating detail on the rigors of the Other Comprehensive Income account found on the balance sheet of most mREITs (mortgage REITs). For now, however, suffice it to say, this is the magic "now you see it now, you don't" account for charges not affecting the income statement, because these charges are non-cash and in many cases, NOT permanent.

Furthermore, in the absence of a market for the securities held by many mREITs, most portfolio managers must use the CMBX and ABX indices to mark their portfolios to the market. As Fitch Ratings pointed out last month, the CMBX is currently indicating a default rate that is four times anything ever seen in the history of the CMBS market. So, managers must mark their portfolios to values that do not correlate with anything even close to actual performance. Does that seem rational?

Unfortunately for REITs that are highly leveraged, these marks can also lead to margin calls which cannot be ignored – hence the aerial somersaults being performed by the funding desk at Thornburg Mortgage (TMA) last week (with a perfect triple twist).

While Thornburg may yet make it (Larry Goldstone is clearly very talented and well-regarded), there are a number of well run, slightly less risky mREITs in the REIT wreckage universe that Mr. Market has put on sale.

Companies such as Northstar Realty (NRF) have funded nearly all of their assets on a long-term, non-recourse basis and are not subject to margin calls. They have cash available to reinvest in a vastly improved (less competitive) lending environment. Mr. Market is literally giving these companies away, offering yields in the high teens and low twenties. Other attractive REIT stocks include Anthracite Capital (AHR), Newcastle Investment (NCT) and RAIT Financial Trust (RAS).

The catch? You must be able to ignore Mr. Market while you push the button and buy from him. Let him serve you, not guide you.

Disclosure: Author holds long positions in the above-mentioned securities.

Comments

[Lisa]

What's an mREIT?

[Ralph F]

Lisa, "mREITs" is Mortgage REITs.

[ACapitalist]

I agree. I have only looked at Newcastle in detail but in Newcastle's case, they only have 16% of their debt in recourse warehouse lines, still have $200 mil of unencumberd assets and $120 mil in cash to meet any further margin calls. They have sold down assets to raise cash. My analysis shows that they will have to cut their dividend this month because their cash flow has been reduced by 10%, at the most 20%. But with paying over a 30% dividend to the current market of $8.50, a cut of the dividend from 72c to 50c or 60c will be seen as positive. In the last earnings confernce call less than two weeks ago, they gave no indication that they would have to eliminate the dividend.

[Hawk]

Looks like your research wasn't too helpful.
NCT just cut their quarterly by 65% to 25 cents

[clyhb]

Northstar Realty downgraded by KeyBanc Capital Mkts
Briefing.com(Tue 7:41am)