As the Federal Reserve has begun to spook the markets with its taper talk and rising interest rate banter, a variety of high yielding asset classes have fallen hard over the recent weeks. From utility stocks to pipeline master limited partnerships (MLPs), anything that is remotely high yielding has seen its value sink.
Perhaps, no sector has felt it worse than the mortgage real estate investment trusts (MREITs).
The paper tigers- which generally offer dividend yields in excess of 10%- have tanked hard on the Fed’s announcements about tapering their quantitative easing programs. While there are plenty of risks still surrounding the sector, investors could be getting a huge deal on shares of the MREITs given that they’ve falling so hard, so fast.
SEE: 5 Types Of REITs And How To Invest In Them
It’s 2008 All-Over Again
At their core. MREITs basically loan money to owners of real estate or -more commonly- purchase existing mortgages or mortgage-backed securities (MBSs). Many of these companies borrow money and then use that leverage to purchase these mortgage-backed securities. These MBS's can be insured by federal agencies (like Ginnie Mae) or those without agency insurance (non-agency). There is different risk-return profiles associated with each of these segments of mortgage bonds, and many MREITs offer a blend of the two. This blend and leverage often results in dividend yields north of 9%
However, the real kicker for the MREIT sector lies within short term interest rates. As these rates rise, so do their borrowing costs. Ultimately, reducing dividend payments available to shareholders. This fact could help explain why the sector has felt such huge declines since Chairman Bernanke gave his statement.
Shares of the largest publically traded MREITs continue to rack-up new 52-week lows. According to data provided by Bloomberg, its index of mortgage REITs has declined by 15% this quarter. That includes reinvesting those high dividends and is on pace to be the worst quarterly decline since the dark days of 2008.
SEE: Profit From Mortage Debts With MBS
Yet, there is still some hope on the horizon.
According to investment bank UBS (NYSE:UBS), the recent sell-off has left many MREITs trading for below book values. This could mean that the interest rate spread widening- based on the Fed tapering- as already been factored into the sector. Secondly, liquidity in the space remains robust, dividends have been held steady and carry income is still good. All in all, these positives could help the beleaguered sector perform much in the second half of the year.
Adding Some MREIT Values
While there can be still more downside for the mortgage REITs, their valuations are getting quite compelling as fear may have tainted the sector. As such, investors may want to begin building positions in some of the names. The iShares FTSE NAREIT Mortgage Plus ETF (NYSE:REM) spreads it’s nearly $1 billion in assets among 33 different MREITs- including Hatteras Financial (NYSE:HTS) and iStar Financial (NYSE:SFI). Over the last quarter, the ETF has fallen by about 18% and sits near a 52-week low. That drop could provide an interesting entry point for portfolios. That will allow investors to pick-up a monster 12.74% dividend yield. At the same time, the Market Vectors Mortgage REIT ETF (NASDAQ:MORT) can be used as well as a broad-play on the MREIT sector.
Perhaps, the best way to play the sector and hedge their own risk is to focus on the hybrid REITs. Hybrid REITs are a combination of traditional real estate companies- which own physical properties- and mortgage REITs. This dual focus decreases the interest rate risk for investors. Both Two Harbors (NYSE: TWO) and Redwood Trust (NYSE:RWT).
However, the prime hybrid MREIT example could be NorthStar Realty Finance (NYSE:NRF). While the firm does own various real estate loans, NRF also owns/operates about $2.4 billion in actual physical buildings and has been growing that portfolio. The latest purchase was back on June 12th, in which NorthStar bought 25 real estate private equity funds. Those office buildings, shopping malls and other buildings will add about $0.18 to distributable cash flows in 2014 and should help boost/strengthen NRF’s 8.4% dividend yield.
The Bottom Line
As the Fed has begun its taper talk, shares of the mortgage REITs have fallen hard. That could make the high yielding sector a potential value for income seekers. The previous picks- along with sector leader Annaly Capital Management (NYSE:NLY) –could make great buys.