In an unprecedented long term low interest rate environment, achieving a decent rate of return on investments demands a step up in risk. Real Estate Investment Trusts fit the bill for attractive high yields, some in double digit territory, but the constant nag of high leverage and the threat of any rise in interest rates create an element of risk not to be ignored.
The quality of the security instruments underlying REITs is a key factor in assessing the effect a change in interest rates might have on the investment. For mortgage back REITs, their income depends on borrowing at low or no interest rates then collecting the higher interest generated from its holdings of long term mortgage debt. The difference between the borrowing rate and the collecting rate is the spread. A rise in interest rates increases borrowing costs, reducing the profits from the spread and lowering the amount of capital available for dividend payouts. A lower dividend yield causes holders to flee the REIT sending its share prices lower.
Some of the best yields today are from mortgage backed or mREITs. Yields above 12% are common. Share prices are off 52 week highs in concert with the broader financial sector’s swoon, reflecting the uncertain climate in worldwide capital markets.
Annaly Capital Management (NLY) is trading in the middle of its 52 week range at almost par with its book value of $16.22. The company’s market cap is $15.74 billion with 40% held by institutions. NLY holdings primarily include agency (government backed with an implicit guarantee) mortgage securities and mortgage backed instruments which helps moderate risk for a healthy yield of 14.20%.To continue reading, click here.