2 REITs Walking a Different Path

12/20/2012 11:00 am EST


Instead of actually managing and holding real estate, this pair hold mortgages. While the niche is small and can be risky, these pass the test, observes Neil J. George of Liberty Investor.

Worried that Congress and the White House will actually do something about the budget for next year? It's possible, and the results would be a combination of higher taxes and some spending cuts. This, of course, is coming at a time when the US economy isn't really firing on all cylinders.

Despite the bump up in gross domestic product for the third quarter to 2.7%, versus 1.3% in the prior quarter, the economy is still sluggish. In fact, it's interesting to note the per-capita GDP rather than just the overall GDP numbers. On a per-person basis, US growth is running at only 0.97%. This might better explain why many Americans aren't feeling all that more productive or successful.

With higher tax bills, all of us will have less to spend and invest, which will put a damper on-if not work to reverse-economic gains.

Then, if we see less spending by the Federal government (which is currently making up 23.9% of the domestic economy with just the straight budget and on-balance-sheet expenditures), it wouldn't take too many calculations to see a negative impact on economic growth in the near term with spending cuts.

The Federal Reserve knows this, and has been working overtime to see what it can do on the monetary policy side to offset the potential fiscal changes on top of the rest of the current economic and market challenges.

The Fed has been very busy buying bonds. As fast as the Department of the Treasury issues them, the Fed has been buying. In fact, in just one of its bond-buying sprees working under the title Operation Twist, the Fed has been buying $45 billion of longer-term Treasuries each month-almost as fast as the Treasury has been issuing them.

And while the Fed has been selling short-term bills and notes, the end result has been that the government's debt is getting longer and longer in average maturity, going from 58.1 months to more than 64.4 months in September alone.

The idea has been that if the Fed can keep buying and stacking up all of the Treasury bonds it can get its hands on, interest rates will stay lower, and there will be more easy cash for the financial markets to remain afloat without having to make real reforms in the banks' and other financials' balance sheets.

While we don't have a full accounting and balance sheet release by the Fed, it is understood that it has been spending some $2.5 trillion on this bond buying and money creation. But it gets bigger and better.

Mortgaged to the Moon
The Fed has not only been buying Treasuries, but it has also been buying mortgages and mortgage bonds. The amounts are running nearly as high as what it's been spending on Treasuries, with monthly mortgage buying by the Fed reportedly running at more than $40 billion.

While we don't get to see the whole balance sheet, the total amount spent is supposedly about $1 trillion or more, and climbing quickly each and every month.

The Fed doesn't just buy mortgages; it has and continues to require all banks (both US banks and foreign banks with offices in the United States) and financial institutions to post mortgages as collateral for reserves and loans. Again, we have no idea how big this amount truly might be. But it would safe to assume that it is a large sum.

The result of this buying and lending has been not just to prop up the mortgage market, but to drive it. The mortgage market in the United States is already getting on a better footing. According to the Mortgage Bankers Association, the number of 90-day (or more) delinquencies, which tends to be a good barometer of pending defaults, continues to fall. And from 2010 to now, the number of delinquencies as a percentage of the overall market is down more than 10.3%.

The number of foreclosures is also falling, with the overall percentage of failings for the past two years dropping by 12.3%. Add in the Fed's heavy buying and lending, and it's no wonder that mortgage rates are low and falling some 24.95% for the same time period.

The result is that the market for mortgages is rallying, much like we've seen in the US Treasury market with the Fed buying heavily in both markets. Overall, mortgage-backed securities as tracked by JPMorgan have risen in price by more than 13.6% from the end of 2009, when the Fed really began to step into this market.

And those gains are on top of the yield earned in this market, which is significantly stronger than US Treasuries.


Take the Fed
There's money to be made here. The key is to own not only what the Fed is buying, but also what the Fed is proven to stand behind if the market turns. Buying mortgages during the turnaround and bailout has become more and more lucrative.

The easy way to participate is to buy companies that buy and own mortgages and mortgage bonds. Structured as real estate investment trusts (REITs), there are many in this segment; but not all are successful. Understanding the underlying mortgages and the structures of mortgage bonds is a specialized science. So it pays to be picky.

But it does pay. The group has performed well, with the Bloomberg Mortgage REIT index up more than 51% since the end of 2009.

There are two worth looking at within this group: MFA Financial (MFA) and Invesco Mortgage Capital (IVR). Both (especially MFA Financial) have proven to perform not just during the recent acceleration in profits over the past year, but also over the past few years, including the time of the more troubling market conditions.

Both trade inexpensively. MFA trades a slight discount to the book of bonds on its balance sheet. Invesco is valued right at book. Both are seeing assets grow-a positive side of the rally in the mortgage market noted above. And both carry some debt, but at a much lower rate with greater capital reserves than major US regulated banks are currently carrying.

Both continue to perform. MFA generated a return of 61.9% since the end of 2009, or an average annual return of 17.4%. Invesco generated similar returns for the period: an overall gain of 62.6%, or an average annual return of 17.6%.

MFA, with a dividend yield of 10%, should be bought ideally below $9 a share. Invesco, with a dividend yield of 12.3%, should be bought ideally below $24 a share.

Read more from Liberty Investor here...

Related Reading:

Are Buybacks the Best Use of Capital?

A Flurry of Special Dividends

Looking Up for Small- an Mid-caps

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