Mortgage real estate investment trusts and related exchange traded funds may be an attractive play at current valuations.
Maxim Group’s Michael Diana argues that mREITs trading on average at 0.85 times March 31 book value with 13.3% yields look like a good play, reports Teresa Rivas for Barron’s.
“We regard mREIT valuations as favorable at present, with average price-to-book value (at March 31, 2015) multiples of 0.85x and average dividend yields of 13.3%,” Diana said in a note. “If book values and dividends remain relatively stable, these stocks should be attractive, in our view.”
The analyst singled out Capstead Mortgage (NYSE: CMO), New York Mortgage Trust (NYSE: NYMT) and Two Harbors Investment (NYSE: TWO).
Instead of meticulously selecting each stock by hand, income investors can also take a look at broad mREIT ETF options. For instance, the Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) has a 9.7% 12-month yield, a 12.3 price-to-earnings ratio and a 0.9 price-to-book. Additionally, the iShares Mortgage Real Estate Capped ETF (NYSEArca: REM) has a 12.8% 12-month yield, 12.6 P/E and a 0.9 P/B.
MORT includes a 3.3% tilt toward CMO, 2.9% in NYMT and 5.3% in TWO. REM includes 2.0% in CMO, 1.6% in NYMT and 5.5% in TWO.
While the recent spike in Treasury yields pressured mREITs, Diana only anticipates a 0.25% hike by the end of the year, followed by a “long pause,” which should have little impact on mREIT fundamentals.
“A 25-bp fed funds rate hike could also push 10-year/ mortgage rates higher, with little impact on net interest rate spreads/dividends,” Diana added. “If expectations of further near-term rate hikes are muted, book values could also remain relatively stable. We expect stabilization with a slight downward bias.”
Mortgage REITs have exhibited a negative correlation to interest rates changes, especially if the yield curve flattens. Many agencies use leverage to capitalize on the arbitrage spread between short- and long-term interest rates, so companies can still make money in a rising rate environment, as long as long-term rates rise faster than the short-term rate or if the yield curve steepens.
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.