A Big-Yielding REIT Ready to Buy

08/10/2012 11:45 am EST

Focus: STOCKS

Nicholas Vardy

Editor, Bull Market Alert, The Alpha Investor Letter, and The Global Guru

Real estate investment trusts have been very popular of late, so you have to be careful when you're buying them so you don't get stuck with overvalued, under-performing picks, notes Nicholas Vardy of Bull Market Alert.

High-yielding US mortgage REITs have been among the market's top performers in 2012.
 
This week's Bull Market Alert recommendation is a bet on the red-hot US REIT sector through American Capital Agency (AGNC). Boasting an eye-popping 14.1% yield, AGNC is already a recommendation in my Dividend Pro trading service.
 
AGNC invests in residential mortgage pass-through securities and collateralized mortgage obligations. The principal and interest payments are guaranteed by government-sponsored entities, or by the US government agencies Fannie Mae and Freddie Mac.

And thanks to Fed policy, the good times for REITs are set to continue for the next few years. Let me explain why...
 
Last month, the Fed announced it would prolong Operation Twist through the end of the year, selling $267 billion of shorter-term securities and buying the same amount of longer-term debt, in a bid to reduce borrowing costs and to spur the economy.
 
Why does this matter to REITs? REITs borrow on the short end of the curve (say, 0.25%) and lend money on the long end of the curve (say, 1.6%). REITs make money on this “spread.” They then leverage this trade up five or even ten times to multiply their profits. These profits are paid out to you in the form of a high dividend—producing an annual yield of over 14% in the case of AGNC.
 
If the Fed intentionally keeps interest rates low on the longer end of the yield curve, it makes it more difficult for REITs to make money. A narrower spread is clearly less profitable for REITs. But the good news is that the Fed also re-committed to its ZIRP (zero interest rate policy) through at least late 2014. So, some kind of “spread” is set to remain.
 
Right now, REITs still have a spread of about 1.35% to "play" with. And, REITs also have the opportunity to increase their profits by increasing their leverage—though this increases their risk, as well.
 
The bottom line? Between a continued interest rate spread and the improving fundamentals of the US real estate market, I continue to believe that US mortgage REITs are among possibly the very best of investment opportunities available to investors anywhere in the world.
 
Within the universe of REITs, AGNC's stock has been one of the strongest performers in the already strong REIT sector, hitting a new 52-week high almost every month. So buy American Capital Agency Corp. at market today, and place your stop at $31.90. For potentially even bigger upside, I recommend the December $37 call options.

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