The Trick Is Buying Before Prices Rise
Summary
- Buying preferred shares isn't hard. It's a great technique to find some attractive risk-adjusted returns though.
- Many investors don't get the trick to it. You want to buy before the price goes up. That way you can be in a positive unrealized total return.
- If you entered correctly, you will often have your choice of opportunities for when to exit (assuming no global pandemic occurring right afterwards).
- We don't always enter positions only to have a quick unrealized gain. It's fun when it happens though.
- NYMTP and NYMTO rallied into our neutral range. This was clear because index cards include price targets.
- This idea was discussed in more depth with members of my private investing community, The REIT Forum. Get started today »
Following reader feedback, we’ve enhanced the layout for this series (yet again!). Your continued feedback is greatly appreciated, so please leave a comment with suggestions.
This article will be heavy on charts because we like to communicate with images, rather than words, whenever possible. Likewise, we will use several tables to more efficiently structure the data. Enjoy!
Mortgage REITs and Preferred Shares
We’ve consistently incorporated a significant allocation to preferred shares in our portfolio. We could simply hold the positions for income, but we take advantage of trading opportunities as well. Our goal is to maximize total returns and this technique has worked wonderfully.
We also trade positions in the mortgage REIT common shares. We find this sector is particularly attractive because it can be so inefficient. Long term, share prices revolve around book value. In the short term, the price-to-book ratios can deviate materially. Simply by understanding that, you can put yourself in a better position.
Our other major source of allocations is equity REITs. While an investor might occasionally choose to trade an equity REIT position, the sector is a great fit for buy-and-hold investors.
We compare our performance against four ETFs that investors might use for exposure to our sectors:
Source: The REIT Forum - Chart runs through 12/31/2020
The four ETFs we use for comparison are:
Ticker | Exposure |
One of the largest mortgage REIT ETFs | |
One of the largest preferred share ETFs | |
Largest equity REIT ETF | |
The high-yield equity REIT ETF. Yes, it has been dreadful. |
When investors think it isn’t possible to earn solid returns in preferred shares or mortgage REITs, we politely disagree. The sector has plenty of opportunities, but investors still need to be wary of the risks. We can’t simply reach for yield and hope for the best. When it comes to common shares, we need to be even more vigilant to protect our principal by regularly watching prices and updating estimates for book value and price targets.
Mortgage REITs and BDCs
We’re including a quick table for the common shares that will be shown in our tables:
Type of REIT or BDC | ||||
Agency | Hybrid | Multipurpose | Commercial | BDC |
The ratings and outlooks we highlight here come after Scott Kennedy provides his weekly updates (requires REIT Forum).
Preferred Shares
This time, we’re focusing on the preferred shares. Let’s run through some recent ratings and trades.
We highlighted some bullish ratings on the NYMT preferred shares recently. For instance, we had these rating cards:
Source: The REIT Forum
I need to highlight for readers that those cards are from 1/28/2021. That’s not today. Sorry, people reading this article from the hospital after waking up from a coma. That was nearly two weeks ago. Now you might wonder why I’m highlighting that. For instance, did our price targets change significantly? No. Our current targets for those shares are $23.43 for NYMTP (up from $23.36) and $23.68 for NYMTO (up from $23.61). In each case, the target increased by about $.07 (given or take a penny rounding error). What happened? Dividend accrual increased our target slightly.
New Cards
Some readers may want new cards. Here you go:
Source: The REIT Forum
Share prices roared higher. Today, NYMTO stands at $24.37 and NYMTP stands at $24.22. In case any readers have forgotten math, I’ll help with an equation:
For NYMTO, we should know the following: $23.20 < $23.61 < $23.68 < $24.37
That means shares were a buy at $23.20, which was less than the price target of $23.61 at the time. Despite the target increasing to $23.68, shares are now above the target, because the price is $24.37.
Easy enough, right?
NYMTP / NYMTO
Since the share prices have rallied above our targets and we don’t simply reset targets the moment they are passed, they are now in the neutral range. That means they don’t get the buy rating any longer. It doesn’t mean that they are a bad deal. It doesn’t mean the dividends won’t be paid. It simply means investors who sat around doing nothing missed out on the attractive price.
We also should mention that after shares rallied materially beyond our clearly-labeled target prices, we reevaluated the position and decided to take our gains.
Source: The REIT Forum
Perhaps we closed the position out a bit too early. We could’ve captured even more upside. However, it’s hard to argue with an 11.29% return for about two months of holding a preferred share.
The position was consistently in a positive total return position:
Source: Yahoo
The trick here was buying before prices increased. So, how did we do that? We need to focus on the entry point.
Entry Point
Our reasoning for purchasing shares in December is laid out nicely in the bullet points of the trade alert:
Do you see the important part? We entered this trade after a review of the entire sector including several peers. It was this review process that reinforced our belief that NYMTP was being undervalued by the market. Quite simply, most investors and analysts struggle with this kind of comparative analysis.
Real Money
One of my pet peeves is people who post about the trades they did in their heads.
Source: Schwab
Source: Schwab
We will close out the rest of the article with the charts we provide for readers to help them track the sector for both common shares and preferred shares.
Let the images begin!
Residential Mortgage REIT Charts
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Source: The REIT Forum
Commercial Mortgage REIT Charts
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BDC Charts
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Notes on Price-to-Trailing Book Ratios - Using Q3 2020 Book Value
Remember that these are price-to-trailing-book ratios. They are not using estimates of current book value. Book values continue to change every day. Scott Kennedy provides frequent updates on estimated book value, ratings, and price targets through The REIT Forum.
Repeated Note: There are two mortgage REITs we need to highlight here:
- AG Mortgage Investment Trust - We're using the Q3 2020 book value reported by management, which does not deduct the value of accrued dividends for preferred shares. If the preferred dividends were paid, it would reduce common book value under these calculations. This method is accepted under GAAP.
- MFA Financial reports “GAAP book value” and “economic book value.” We’ve chosen to use the GAAP book value to remain consistent.
Unfortunately, we have to repeat those bullet points every time we publish because it regularly comes up if we don’t mention them.
Notes on Price-to-Trailing Book Ratios - Using Q4 2020 Book Value
This chart isn’t ready yet because we haven’t had that many reports. However, we will be adding it to the sheet soon. For a while, we will be running price-to-trailing book ratios in two charts. Why? Investors shouldn’t compare the price to Q4 2020 book value for one REIT against the price to Q3 2020 book value for another REIT. By simply providing two charts, we will enable investors to ensure they are using comparable data.
Notes on Common Share Dividend Yield
Dividend yield often comes up in the comments, but picking based on dividend yield is stupid and regularly results in terrible performance. Don’t do it.
This chart is still in the same order as the prior charts. Consequently, you know the highest price-to-book ratios (using trailing GAAP book value) for each segment will be at the top. If you see a mistake, please feel free to say something. Occasionally the data for dividend rates requires a manual update.
Notes on Earning Yields
One of the next things investors may ask about is the yield using core earnings. This chart puts together the core earnings based on the consensus analyst estimate. Beware that the consensus estimate may not always be the best estimate. Further, there are ways to increase “Core Earnings” through accounting decisions or modifying hedges. Consequently, investors should still take these values cautiously. We do not depend on the consensus estimate to make decisions.
Preferred Share Charts
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Notes on Preferred Share Prices
This chart gives you a pretty quick feel for which shares are trading at a discount to call value. Each of these preferred shares has a call value of $25.00, but that doesn’t mean a share will be called. The company decides if they want to issue a call or not.
Notes on Dividend Yield / Stripped Yield
Stripped yields are vastly more useful than “current” yields for preferred shares. The stripped yield uses the stripped price. That’s different from using the current price, because it means we already adjusted for dividend accrual. This makes the process easier for investors.
We can talk about shares using “regular prices”. Those are the prices an investor would actually use when entering an order.
However, we will provide the stripped yield to adjust for the dividend accrual. In the spreadsheets we host for subscribers, we include the actual ex-dividend date, or the projected ex-dividend date if the actual date isn’t yet known. If you’re planning to buy a share, it’s always wise to check if the shares just went ex-dividend so you can adjust your targets accordingly.
Notes on Floating Yield on Price
Since many of these shares switch over to floating rates, we also want to consider what the yield would be if the floating rate was in effect and shares were still at the current price. To demonstrate that, we use the “Floating Yield On Price.” If the share remains at a fixed-rate indefinitely, then the value doesn’t change.
One point we need to emphasize here is that we are dealing with yields. A yield must involve the share price. We aren’t simply showing the new “rate” if the share began floating, we are adjusting the new rate for the stripped price.
Floor
XAN-C has a floor that interferes with the eventual floating rate. The floor prevents the floating rate from being less than the initial fixed rate. Consequently, while XAN-C is one of the FTF shares, it doesn’t exhibit the same decrease as other FTF shares when we switch over to the “Floating Yield on Price”. However, it remains a higher-risk share because of the type of assets the REIT owns.
Preferred Share Data
Beyond the charts, we’re also providing our readers with access to several other metrics for the preferred shares.
After testing out a series on preferred shares, we decided to try merging it into the series on common shares. After all, we are still talking about positions in mortgage REITs. We don’t have any desire to cover preferred shares without cumulative dividends, so any preferred shares you see in our column will have cumulative dividends. You can verify that by using Quantum Online. We’ve included the links in the table below.
To better organize the table, we needed to abbreviate column names as follows:
- Price = Recent Share Price - Shown in Charts
- BoF = Bond or FTF (Fixed-to-Floating)
- S-Yield = Stripped Yield - Shown in Charts
- Coupon = Initial Fixed-Rate Coupon
- FYoP = Floating Yield on Price - Shown in Charts
- NCD = Next Call Date (the soonest shares could be called)
- Note: For all FTF issues, the floating rate would start on NCD.
- WCC = Worst Cash to Call (lowest net cash return possible from a call)
- QO Link = Link to Quantum Online Page
Ticker | Price | BoF | S-Yield | Coupon | FYoP | NCD | WCC | QO Link | P-Link |
$24.80 | FTF | 6.99% | 6.88% | 4.61% | 4/15/2024 | $5.79 | |||
$25.24 | FTF | 6.99% | 7.00% | 5.31% | 10/15/2022 | $2.82 | |||
$24.44 | FTF | 6.70% | 6.50% | 5.36% | 10/15/2024 | $6.66 | |||
$23.89 | FTF | 6.46% | 6.13% | 5.17% | 4/15/2025 | $7.62 | |||
$25.05 | FTF | 7.03% | 6.95% | 5.26% | 9/30/2022 | $2.99 | |||
$25.00 | FTF | 6.58% | 6.50% | 4.43% | 3/31/2023 | $3.65 | |||
$25.09 | FTF | 6.82% | 6.75% | 5.24% | 6/30/2024 | $5.82 | |||
$24.72 | 7.12% | 7.00% | 7.12% | 1/28/2025 | $7.28 | ||||
$25.11 | FTF | 6.92% | 6.90% | 5.68% | 4/15/2025 | $7.21 | |||
$25.00 | 7.57% | 7.50% | 7.57% | 3/9/2021 | $0.27 | ||||
$24.05 | FTF | 7.05% | 6.75% | 5.64% | 10/30/2024 | $7.28 | |||
$23.87 | FTF | 7.90% | 7.50% | 6.33% | 8/15/2024 | $7.70 | |||
$22.90 | FTF | 7.82% | 7.13% | 6.42% | 8/15/2024 | $8.34 | |||
$21.17 | FTF | 7.57% | 6.38% | 6.14% | 2/15/2025 | $10.22 | |||
$25.05 | FTF | 8.24% | 8.13% | 6.12% | 3/15/2024 | $6.55 | |||
$24.93 | FTF | 8.15% | 8.00% | 6.31% | 6/15/2024 | $7.07 | |||
$24.77 | Bond | 6.91% | 6.75% | 6.91% | 3/9/2021 | $0.61 | |||
$25.00 | Bond | 6.66% | 6.63% | 6.66% | 3/9/2021 | $0.16 | |||
$24.81 | 8.17% | 8.00% | 8.17% | 10/30/2021 | $1.78 | ||||
$23.48 | FTF | 8.64% | 8.00% | 6.47% | 3/30/2024 | $7.94 | |||
$23.12 | FTF | 8.49% | 7.75% | 5.42% | 9/30/2025 | $11.01 | |||
$22.92 | FTF | 8.85% | 8.00% | 6.17% | 3/30/2024 | $8.50 | |||
$25.31 | FTF | 8.08% | 8.13% | 5.83% | 4/27/2027 | $12.38 |
Second batch:
Ticker | Price | BoF | S-Yield | Coupon | FYoP | NCD | WCC | QO Link | P-Link |
$24.40 | FTF | 7.86% | 7.63% | 5.73% | 07/27/2027 | $12.98 | |||
$23.37 | FTF | 7.81% | 7.25% | 5.61% | 01/27/2025 | $8.88 | |||
$25.25 | 7.74% | 7.75% | 7.74% | 03/09/2021 | $0.01 | ||||
$25.25 | 7.49% | 7.50% | 7.49% | 3/9/2021 | $0.01 | ||||
$25.89 | 7.99% | 8.20% | 7.99% | 8/17/2022 | $2.28 | ||||
$24.89 | FTF | 8.37% | 8.25% | 5.92% | 4/15/2024 | $6.73 | |||
$24.80 | 7.88% | 7.75% | 7.88% | 3/9/2021 | $0.45 | ||||
$24.32 | FTF | 8.09% | 7.75% | 5.62% | 12/27/2024 | $8.45 | |||
$24.34 | FTF | 7.82% | 7.50% | 5.72% | 9/27/2027 | $13.33 | |||
$23.85 | FTF | 8.33% | 7.88% | 7.02% | 1/15/2025 | $9.02 | |||
$24.00 | FTF | 8.41% | 8.00% | 6.20% | 10/15/2027 | $14.50 | |||
$24.38 | 8.15% | 7.88% | 8.15% | 3/9/2021 | $0.90 | ||||
$24.22 | 8.07% | 7.75% | 8.07% | 3/9/2021 | $1.06 | ||||
$24.40 | 7.80% | 7.50% | 7.80% | 3/9/2021 | $0.95 | ||||
$22.22 | FTF | 7.42% | 6.50% | 6.33% | 3/31/2025 | $9.68 | |||
$22.80 | 7.77% | 7.00% | 7.77% | 5/12/2022 | $4.51 | ||||
$22.50 | FTF | 9.30% | 8.25% | 6.61% | 3/30/2024 | $9.12 | |||
$23.05 | 9.12% | 8.25% | 9.12% | 3/9/2021 | $2.38 | ||||
$21.80 | 9.35% | 8.00% | 9.35% | 3/9/2021 | $3.62 | ||||
$21.24 | FTF | 9.60% | 8.00% | 8.02% | 9/17/2024 | $11.24 | |||
$23.75 | FTF - Floor | 9.17% | 8.63% | 9.17% | 7/30/2024 | $8.79 |
There are a few things you should know at the start:
- When a share can be called on short notice, the annualized yield-to-call reaches absurd levels. Investors shouldn’t put too much weight on it. On the other hand, a negative number can be a significant concern. Consequently, we decided to include it in the chart.
- We sort our spreadsheet for subscribers by risk ratings within each sector. We decided to use the same technique for this series since it communicates more information to readers. You’ll notice a general correlation where lower risk correlates with a higher price and lower yield, though this link isn’t absolute.
- Worst Cash to Call example: Imagine a preferred share which could be called in a few months and would pay out a total of $.75 in dividends by that time. If an investment in those shares ends in a call, the smallest amount of cash inflows possible would be $25.00 (call value) plus $.75 (total dividends). If the share price was $25.60, then the “Worst Cash to Call” would be $.15. That comes from the following equation: $25.00 + $.75 - $25.60 = $.15. If the share price increased by $.20 in the next hour, the “Worst Cash to Call” would decline to negative $.05.
Conclusion
You don’t have to follow us. You don’t have to care about our research. If you’re happy with a high dividend yield and a dwindling account value, there are plenty of authors who can cater to you. On the other hand, if you’re focused on generating total returns and want to use REITs to do it, you may love our research. Hit the “Follow” button beside my name to start seeing more of our research.
Make sure to leave a comment and let us know what you think of the layout.
Ratings:
- Neutral on NYMTP / NYMTO because they rallied above our price targets.
The REIT Forum utilizes over 5,000 hours per year in research. You can access that research for just pennies per hour.
To produce our research, we need to access several expensive data sources. Our total expenses now run over $100,000. If you want to duplicate our service, you'll just need several decades of experience, 5,000 hours per year, and over $100,000 for your budget. We use the time and money to provide a superior experience:
It's time to try our service.
This article was written by
Disclosure: I am/we are long AGNCO, NYMTM, CIM-A, AGNCP, ARR-C, NRZ-B, NRZ, AGNC, NLY, SLRC, GPMT, PMT, ORCC, CMO. 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.
Additional disclosure: As a reminder, Scott Kennedy also is an author for the REIT Forum. You may see his commentary featured in our articles and may notice an extremely high amount of overlap in our ratings, so subscribers reading this article should see Scott’s latest REIT Forum sector update for more detail.