Monday August 13, 2012
by Nicholas Vardy, editor Bull Market Alert
We are betting on the red-hot U.S. REIT sector through American Capital Agency Corp. (AGNC). Boasting an eye-popping 14.1% yield, 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 U.S. 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.
The Fed has 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 5x or even 10x times to multiply their profits. These profits then 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 U.S. real estate market, I continue to believe that U.S. mortgage REITs are among possibly the very best of investment opportunities available to investors anywhere in the world.
Despite a sharp sell-off last week, Gary D. Kain, AGNC's chief investment officer, bought 20,000 shares of AGNC at an average price of $32.75 for a total investment of $655,000. Kain clearly saw an opportunity during the sell-off, and pounced quickly.
Learn more about this financial newsletter at Nicholas Vardy's Bull Market Alert.