After the Fed Meeting: Time to Buy Mortgage REITs

Two weeks ago, I recommended that investors jump into high-quality equity REITs such as Realty Income (O) and National Retail Properties (NNN).  Both have since rallied hard, but it’s not too late to buy if you haven’t already.  Consider these worthy additions to your “sleep at night” portfolio.

But what about the more speculative parts of your portfolio?  After the bloodletting of May and June, where might the real values be?

Surprisingly, in mortgage REITs.

I say “surprisingly” because I generally hate mortgage REITs.  They are highly-leveraged “hedge-fund like” vehicles that few investors really understand.  And because they don’t understand them, they tend to pay too much for them…and then eventually get burned.

This is exactly what happened in the mortgage REIT space over the past year.  Desperate for yield and willing to chase high dividend yields irrespective of sustainability, investors bid most mortgage REITs well above their book values. 

It was a disaster waiting to happen, and when the Fed’s “tapering” comments hit the market, it did.  As a sector, mortgage REITs lost nearly a quarter of their value in just two months.

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NOW WHAT?

For the remainder of 2013, I expect mortgage REITs to be one of the best performing asset classes.  After the sell-off, most sell for well below book value.  And importantly, with Bernanke clarifying yesterday that short-term rates would remain low for the “foreseeable future,” the fundamentals are also markedly improving.  A steeper yield curve provides a wider spread for the mortgage REITs and makes the dividend far more sustainable. 

ACTION TO TAKE

Buy a basket of mortgage REITs, or simply buy the Market Vectors Mortgage REIT Income ETF (MORT).  The dividend is something of a moving target, but at current prices the yield is just over 10%.  Collect the dividend and enjoy what I expect to be a monster rally in the share price.  Use a 15% trailing stop. 

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