Two Harbors Investment: A Winning REIT Pick

| About: Two Harbors (TWO)

With interest rates remaining at historical lows, REIT investors have been nicely rewarded with growing share prices and healthy dividend yields. In some instances, especially in light of the recovering real estate market, REIT shares have risen year to date by as much as 20% or more.

While both the current and expected performance of most REITs has been positive, there is one REIT in particular that I feel could be a real winner in terms of longer-term income and growth due to its diversified portfolio and income-generating strategies. In this article, I will discuss why Two Harbors Investment (NYSE:TWO) is a great fit for REIT buyers.

Although Two Harbors recently cut its dividend, the company still offers a nice yield of over 12%. Over the past 12 months, Two Harbor's sales growth has increased by more than 400%, with income growth in excess of 250%. The company feels that this is due in large part to its diversified asset portfolio that consists of both agency and non-agency mortgage-backed securities, as well as the firm's purchase of foreclosed single-family properties from big banks that are subsequently rented out for income generation.

Upon purchase of these homes, Two Harbors rolls the properties into an entity named Silver Bay Realty Trust. This trust has recently registered for its own IPO. Although Silver Bay is a new offering, it has an advantage when seeking financing from lenders in that it is owned by Two Harbors.

Two Harbors has a P/E ratio of 9, which is actually below that of the real estate industry overall of closer to 10, and substantially lower than the P/E ratio of 17.7 for the S&P 500 index. Shares of Two Harbors have recently been trading at a premium of 20% to book value, and it is anticipated that the company will continue to generate more than enough cash from operations in order to sustain its dividend for both the short- and long-term time horizon.

How Other REITS Shake Out

Other REITs are, for the most part, faring well in this low interest rate environment, as well as from the Federal Reserve's recent quantitative easing (QE3). Under this plan, the Fed will be purchasing roughly $85 billion in mortgage-backed bonds each month through the rest of 2012. Then, beginning in 2013, the Fed will continue on its buying spree, snapping up approximately $40 billion per month. This should spark an increase in demand for these securities, and likewise drive up the value of the securities that are held in many REITs' portfolios.

One REIT that stands to gain from this plan is Annaly Capital Management (NYSE:NLY), as the expected price increase in agency backed securities will also likely raise the book value of the company's overall portfolio.

Annaly is one of the largest REITs, having a total enterprise value in excess of $114 billion. Because the company's management team has experience in nearly all market conditions and interest rate scenarios, this REIT should be able to weather any raise in rates over the longer term. In the meantime, Annaly offers a dividend of $2.00 per share and a yield of over 11%.

Another REIT that continues to offer a dividend yield that exceeds 12% -- even after a recent dividend cut -- is Cypress Sharpridge Investments (NYSE:CYS). With a market cap of close to $2.5 billion, CYS invests in residential mortgage pass-through securities on a leveraged basis. These securities have both principal and interest payments that are guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae.

Over the past 12 months, CYS has increased its sales growth by over 200%, and its income growth by nearly 1,300%. The shares are rated in large part as a Strong Buy, and I tend to agree that investors will likely be happy with an investment in this REIT.

American Capital Agency (NASDAQ:AGNC) also has momentum on its side thanks to low interest rates and the effects of QE3. This REIT has been offering a dividend yield of more than 14%, although it is felt that the amount of leverage the company currently holds could be negative if there happens to be an unexpected rise in interest rates in the near future. In any case, American Capital has seen an increase in sales growth over the past 12 months in excess of 330% and a corresponding rise in income growth of 167%. This equates to a net profit margin rise of nearly 50%.

Even with all of the positive news for REITs there is one that investors should shy away from, at least for now. Although Chimera (NYSE:CIM) had previously been rewarding its investors with a dividend yield of approximately 20%, the company has had troubles of late -- starting with its announcement of restating its financials from as far back as 2008. This could not only have an effect on share value, but also -- unless the company files its 2011 10-K by mid-January 2013 -- its shares could even be delisted from the New York Stock Exchange.

The Bottom Line

With very few exceptions most REITs have been performing in positive territory over the past few years especially, due in large part to lower interest rates. In taking advantage of lower property prices -- while also taking part in higher demand for their portfolio assets thanks to the Fed's QE3 efforts -- investors in these entities have been well-rewarded.

I feel as if those investors who own shares of Two Harbors will be especially benefited by this particular REIT thanks to its solid 12% dividend yield and higher anticipated share price -- thanks in large part to the firm's diversified income strategy. This is particularly the case if shares can be picked up for under $10.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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