Friday, January 18, 2013

REITs

I am reaching the point where I either have to take some more risk, or I will be stuck at my day job forever, instead of doing something that really matters to improving our society.  I have been looking at some REITs (Real Estate Investment Trusts) that have pretty decent dividends, such as American Capital Mortgage Investment Corp (MTGE), which has a 14.02% yield as of the close of business today, and Apollo Residential Mortgage Inc (AMTG) with a 12.77% yield.  I realize that these returns imply some risk, and I would not buy more than 500 or 1000 shares of any particular REIT, and no more than 15% of total portfolio in REITs of all sorts.  Any suggestions on things to watch for?

5 comments:

Jim Dunmyer said...

Clayton,
I wouldn't be real hung up on dividends, just plain ol' growth is good, too. If an investment is growing at 7%/year, you can sell off 5% every year for pocket money/living expenses and still see your portfolio grow. Basically, that's the way we operate, our Edward Jones guy takes care of the details.

James B. Shearer said...

First "... I either have to take some more risk, or I will be stuck at my day job forever, ..." this is a dangerous way of thinking. Any number of troubled public employee pension funds have made their situation worse by taking chances that didn't pay off instead of planning based on realistic rates of return.

These REITs appear to be achieving their rates of return roughly as follows. Start with $1 in equity. Borrow about $5 short term at about 1%. Buy $6 of longer term RMBS (residential mortgage backed securities which are pools of residential mortgages) yielding about 3%. So you are earning $.18 interest while paying $.05 interest for a net yield of about 13% against your equity. This is not a model that appeals to me. The RMBS will be used as collateral for the short term loans. If residential mortgage rates rise the value of existing RMBS will decline and you get the equivalent of a margin call and have to take losses magnified by the leverage (and possibly liquidity issues).

As to what to watch for, you want honest and competent (there are lots of subtleties to RMBS and the funds are also using hedging strategies against some interest rate moves) management, low expenses and to buy at a good price. I didn't try to evaluate management. It seems that expenses are $.12 a quarter compared to a dividend of $.90 for MTGE and $.16 a quarter compared to a dividend of $.85 for AMTG. So MTGE is better here. But MTGE is selling at 1.02 times book (which should be the net value of the underlying securities) while AMTG is selling at .77 times book. This is a pretty big difference and I suspect there is something I don't understand that explains it (AMTG also has preferred stock which complicates things). Or maybe the market just likes MTGE's management as compared to AMTG's.

Personally if I was going to take chances I think I would look at things like HP stock. Not saying HP itself is a good bet (I have no idea) but if it did turn around the upside is more than 14%.

I assume this is for a tax deferred account like an IRA or 401k otherwise you are taking a tax hit by investing in high yield securities.

I am not an investment professional and could be making some stupid mistake so don't rely on any of this stuff without checking it yourself.

Dave said...

Do they have the earnings to pay the dividend? I remember talking to my dad about a company that actually had to borrow money to keep up the dividend payment, and the dividend payment was the only thing keeping the value of the stock from dropping...

I think the company that was borrowing to pay the dividend was Occidental Petroleum, but I'm not sure.

Dave said...

Also, since they are apparently backed by mortgages, does the yield include principal repayment?

Stan Burton said...

My solution was to cut out the middlemen and just buy the properties myself and refurb them and rent them out. my thinking is/was that if I have a large enough stable of rental properties then I can eventually replace my income from work with rental income (I figure I would need about six to replace both my income as well as my wife's.) if you do a lot of your refurb work yourself then the ROI should be about 5 years per property, at least with the market prices and rents I can get in Houston. your RE markets may differ.