In the final part (here) of the Protected Principal Retirement Strategy: Putting It All Together, I alluded to the fact that it was difficult to find a suitable mortgage real estate investment trust (mREIT) to add to the portfolio holdings. It still is!
Much has been written on SA about the mREITs, and what wonderful investments and income generators they have been in recent times. In reading these articles I have wondered where these authors were in late 2008 and early 2009 when the mREIT sector completely tanked and several of the largest (and most profitable) disappeared from our holdings completely.
While it is true that several mREITs have been no less than stellar performers over the past two years, there are ominous signs that a replay of 2008 and 2009 could be just around the corner.
Our portfolio is predicated upon securing an adequate level of annual dividend (8+/- percent) income without "chasing" many of the extremely high-yield stocks. The mREIT asset class is a completely different animal as few of these yield less than double digits.
We currently own shares of Newcastle Investment Corp. (NCT), which has been in an uptrend since its lows in the $3.75 range, made in October 2011. The quarterly dividend was also increased by 33 percent first-quarter 2012.
I have never felt comfortable with only one holding in a specific asset class, so a few months back I began to research approximately 20 of the most popular mREITS.
Having not been prudent enough to exit from my four mREIT positions anywhere close to the top in 2008, I watched as dividends were reduced and stock prices tumbled before I recovered from the initial shock and sold them all for a significantly reduced profit.
Not wanting to relive this, the first criteria for reducing my list of 20 mREITs to a more manageable group was to eliminate each one that has, for one reason or another reduced its dividend over the past few quarters. This quickly got my list down to eight (seven, not including NCT), and eliminated some of those most favored here on SA, including: Annaly (NLY), American Capital Agency (AGNC), Capstead (CMO), Chimera (CIM), Armour (ARR), Resource Capital (RSO), Hatteras (HTS), and MFA Financial (MFA) my top candidate for portfolio inclusion.
Survivors of the first cut were:
- American Capital Mortgage Investment (MTGE)
- Apollo Residential Mortgage (AMTG)
- Dynex Capital (DX)
- Two Harbors Investment Corp. (TWO)
- PMC Commercial Trust (PCC)
- PennyMac Mortgage Investment Trust (PMT)
- New York Mortgage Trust (NYMT)
Earnings, Interest Spreads, And Dividend Coverage
In order to further reduce my list of candidates I examined most recent quarterly earnings releases. I wanted to see how many (if any) of my remaining candidates had net income per share that met, or exceeded the dividends that they declared.
Of the seven mREITs remaining, only MTGE, DX, PMT, and NYMT had net income per share that covered their declared dividends. In addition, there were more mREITs reporting tightening interest rate spreads than expanding spreads.
None of four remaining mREITs reported a book value that exceeded its stock price; although all came quite close.
The only one of the four showing a compound annual growth rate [CAGR] in excess of five percent for the coming five-year period was PMT.
There Must Be A Better Way
My thoughts going into this evaluation were that I could identify perhaps two or three mREITs suitable for inclusion in the portfolio. I realize that in all probability I would not be holding any mREITs for a time period in excess of one year. At some point on the horizon the consequences of our country's reckless spending, coupled with the printing of money on a 24/7 basis will come home to roost in the form of interest rates increases and/or increased inflation (not that inflation hasn't already increased). Neither of these conditions are favorable for the mREIT asset class.
In doing the research I came across a few articles about the iShares FTSE NAREIT Mortgage Index ETF (REM).
I have mentioned in the Protected Principal Retirement Strategy series that I was neither partial to, nor particularly knowledgeable of Exchange Traded Funds. Perusing the information I could find on REM, I noted that virtually all of the large-cap mREITs are a part of the portfolio. REM has an expense ratio of 0.48 percent, a fairly high turnover rate, has returned over 19 percent year-to-date, and sports a yield of just over 11 percent. Quarterly dividends have also been increasing.
Best of all for a semi-retired mid-ranger, REM trades at less than book value and has a relatively low beta of .57.
Since many SA readers and contributors have a better knowledge of ETFs than I, I would be interested in hearing your thoughts on utilizing REM as a means to participate in the mREIT asset class.
Disclaimer: The content of this article is in no way intended to constitute a "buy" or "sell" recommendation on any stock or fund.