The Number One mREIT To Own In An Unstable Economy

Includes: CIM, CYS, NLY
by: Cris Frangold

As the economic climate moves forward in its low interest rate environment, many REITs continue to reward their investors - although not quite as steadily as they did in the past year or so. Over the past several years, mortgage REITs have been fairly successful as the cost of borrowing to purchase securities and bonds has been quite a bit lower than the yields that are received. Yet, recently, there have been some concerns with regard to the current spread that these REITs receive on their purchases.

Now that the Fed has hinted at keeping the historically low interest rate environment alive and well through 2015, the yields are continuing to drop, forcing an abnormally low spread between these yields and the funding that is used by the REITs. In this article, I will discuss why the momentum of some REITs may be slowing down, and which ones should continue their upward movement in providing growth and income to their shareholders.

Agency REITs such as Annaly Capital Management (NYSE:NLY) have been a favorite over the past few years for investors who seek the security of taxpayers who backstop their investments. But as the months have gone on, this once "easy money" has been harder to come by as the Fed continues to promote the quantitative easing.

While Annaly's dividend is still providing investors with a yield that is in excess of 12.5%, the company's share price is only expected to rise by 4.8% over the next 12 months. And, although this is certainly a respectable amount of growth in comparison to the past overall market performance, it pales a bit in the recent world of REITs.

In addition to concern over the yield spreads, Annaly is also likely to soon have some major changes at the top. After the recent passing of Michael Farrell, the firm's well respected co-CEO - who was also said to have the richest pay package in the real estate industry - it is uncertain how his replacement will steer the ship.

Also, Annaly recently announced a stock buyback program of approximately $1.5 billion. This buyback is expected to take place over the next year, and is anticipated to help support the REIT's stock as prepayments increase. Currently, Annaly's P/E ratio is quite high, standing at over 28.5, while the REITs share price is only expected to rise by less than 0.5% over the next year.

Other former high-flying REITs such as Armour Residential REIT (NYSE:ARR) and American Capital Agency (NASDAQ:AGNC) have lost some ground lately as well - especially after Ben Bernanke's third round of quantitative easing, which has kept the interest rate environment artificially low. In fact, due to the vast amount of mortgage refinancing, as well as a rise in bond prepayments, American Capital's current P/R ratio stands at 16.5, and its shares are down roughly 6% since the end of 2012's second quarter alone - although American Capital's dividend is in the 15% range.

Presently, Armour has not reported a current P/E ratio. Yet, while Armour does not currently offer a dividend, its share price is estimated to increase by nearly 12% over the next year - which could make this REIT a good value for those who seek share growth.

One REIT that has continued to benefit from the Fed's monetary policy - even with a recent dividend cut - is Chimera Investment (NYSE:CIM). With the continued low interest rates, this REIT has reaped the benefits of larger interest rate spreads. Chimera recently lowered its quarterly dividend from $0.11 per share to $0.09 per share - but with a dividend yield that is still in excess of 14%, the pullback hasn't seemed to affect this REIT quite as much as some of the others. This REITs P/E ratio of 4.87 is a bit more in line than some of the others. In addition, the REITs share price is expected to rise approximately 2% over the next 12 months.

While the numbers are still positive, though, there is one concern in that Chimera has not officially reported its financial results since the third quarter of 2011 - so while this REITs shares may offer a great value, investors should at least be aware that there could be some negative movement in the future if the company's real numbers don't quite match up with the estimates over the past year.

Yet another of the mortgage REITs that could offer a nice amount of value to investors is CYS Investments (NYSE:CYS). This REIT also has recently lowered its dividend - from $0.50 per share to $0.45 - in the second quarter 2012, giving it a yield of just under 14% and a P/E ratio of just below 6. On top of that, CYS's share price is estimated to increase over 9% over the next year.

The momentum - and the outlook - for CYS is moving in the right direction, as the company recently reported third quarter 2012 net income of over $241 million versus just under $102 million in the prior quarter.

The Bottom Line

While many analysts have been bullish on mortgage REITs over the past year or so, some of this excitement has worn off due in large part to the Fed's quantitative easing efforts. With this, however, it has been easier to choose which of the REITs will likely continue moving forward in the longer term.

Although numerous REITs are still providing double digit dividend yields to their investors, a few have dropped off in the growth area. REITs such as CYS, though, have continued to provide nice steady dividend income along with the potential for nice growth.

Investors who are still seeking value from the world of REITs would do well to stick with CYS Investments. The combination of both income and growth prospects appearing to be solid - even in the midst of a pullback - could make this one a REIT to hang onto for the long-term.

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.