Unloved for much of 2013, real estate investment trust, or REIT, related exchange traded funds are now looking quite cheap and offer robust yields.
Mortgage REITs now trade at a 20% discount to the book value of its underlying holdings, reports Lewis Braham for Bloomberg.
Michael Widner, a REIT analyst at KBW Bank, believes the sector could generate over 20% in returns this year as the discount is priced out, combined with REITs’ attractive yields.
However, many have been wary about diving into mREITs in a rising rate environment since bond prices, the underlying holdings, fall as rates rise.
David Cohen, manager of the Eudora Fund, though, argues that investors shouldn’t be too concerned about higher rates because mREITs utilize complex hedging strategies to limit rate risk. For instance, Annaly Capital Management Inc (NLY) has hedged half of its portfolio.
“The management team is more seasoned than teams at most other mortgage REITs,” Cohen said in the article.
REITs generate cash by profiting on the spread between long-term rates and short-term rates. The companies borrow money on short-term rates and use the money to purchase long-term bonds, so they generate larger yields on wider spreads.
With the Fed keeping its short-term rates near zero while benchmark 10-year Treasury yields hover around 3%, the spread between the two is at about its widest in 35 years, Cohen said. Consequently, profit margins at mREITs could rise.
Looking ahead, any tapering to the Fed bond purchasing program would likely push up long-term yields only. Meanwhile, the Fed has stated that it will maintain low short-term rates, given the current low inflation and relatively high unemployment environment.
The Market Vectors Mortgage REIT Income ETF (MORT) and the iShares Mortgage Real Estate Capped ETF (REM) are two ETFs that track mREITs. Both funds have significant exposure to Annaly and American Capital Agency Corp (AGNC) – MORT has 12.7% in NLY and 10.3% in AGNC while REM holds 14% in NLY and 11.3% in AGNC.
MORT shows a 14.24% 12-month yield, and REM offers a 16.1% 12-month yield. [Despite Headwinds, mREIT ETF Dividends Endure]
MORT is up 3.1% over the last month and up 1% over the past three months. REM has gained 6.8% over the last month and 4.3% over the last three months.
iShares Mortgage Real Estate Capped ETF
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.