Big Yields In Mortgage REITS

By Aaron Levitt | June 30, 2011 AAA

Finding income sources remains a top priority for the nation's Baby Boomers as they head into their golden years. Many have sought refuge in a variety of high-yield sectors. Real estate investment trusts (REITs) are one area of the market that has received much investor attention. With the rebounding commercial real estate markets and general economic recovery, REITs have been become a popular destination for income seekers. Funds like the SPDR Dow Jones REIT (NYSE:RWR) have swelled with assets, as investors have sought exposure to the higher yielding trusts. However, with the Federal Reserve signaling that it kept interest rates low, one sub-sector of the REIT marketplace may be the perfect place to find high income potential.

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Paper Tigers
When most investors think of real estate investment trusts, they think of equity REITs or those that invest in and physically own properties. These companies own shopping malls, office buildings and warehouses, and then collect rent from tenants. However, less than 10% of the sector falls into the category of mortgage REITs. This variety of real estate investment trust loans money to owners of real estate or, more commonly, purchases existing mortgages or mortgage-backed securities (MBSs). Many of these companies borrow at near-zero interest rates, courtesy of the fed, and then use that leverage to purchase 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%.

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. However, with the economy still trudging alone in second gear, it may be even longer than expected before the Fed hikes rates. Bernanke has already hinted that reducing the Fed's multi-trillion dollar balance sheet will be the first step of monetary tightening. As rates continue to hover near zero, borrowing costs for the MREITs will remain cheap. In addition, with the end of the Fed's quantitative easing programs, yield and dividends could trump growth.

Playing the Spread
For those investors looking to add a little spice to their income portfolios, mortgage REITs make an ideal choice for gaining some yield. The sector isn't without risk, but with rates staying next to zero, it could offer some outlandish dividends for at least a year or so. Individuals who wish to take a broad approach to the sector, the iShares FTSE NAREIT Mortgage Plus Capped Index (NYSE:REM) follows a basket of 50 mortgage REITs as well as banks with strong mortgage operations. Top holdings include Hudson City Bancorp (Nasdaq:HCBK) and Two Harbors Investment (NYSE:TWO) and the ETF yields 10.35%.

The "best of breed" play within the MREIT sector has to be Annaly Capital (NYSE:NLY). Focusing on agency bonds, Annaly has impressively managed to navigate the waters of the Great Recession, and recently upped its dividend raised its dividend from 62 cents per share up to 65 cents, and yields 14%. For those looking for riskier non-agency play on Annaly's success, Chimera Investment (NYSE:CIM) is managed by a subsidiary of the MREIT. Chimera yields 14%.

For those looking for truly high yield, asset manager and PowerShares ETF sponsor, INVESCO (NYSE:IVZ) created INVESCO Mortgage Capital (NYSE:IVR) during the height of the credit crisis to in order to bottom-fish some of the deals in the MBS space. IVR recently raised $394 million in a secondary offering, which the company will use to buy additional securities. Shares of IVR yield just over 18% and trade at approximately a 5% discount to book value.

Finally, for investors looking for analyst direction for their MREIT investment, JMP Securities recently upgraded both American Capital Agency (Nasdaq:AGNC) and Hatteras Financial (NYSE:HTS) from "perform" to "outperform". Shares of these MREITs yield 19.4% and 14.5%, respectively.

The Bottom Line
As the search for income continues, the mortgage REIT sub-sector could be just what investors are looking for. As the Federal Reserve keeps interest rates at near zero levels, stocks in the MREIT sector such as Cypress Sharpridge Investments (NYSE:CYS) should continue to do well and add extra oomph to a dividend portfolio.

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