Increasing focus on mortgage REITs

I apologize for the hiatus in posting the last few days. We currently have the RV parked in the Gila National Forest in a pretty remote location with no power, no communications. It’s a 23 mile drive down the mountain to the nearest access. Good thing there is a good barbeque place on the way for extra incentive. Now, on to my post for today.

It’s getting tougher these days to find under priced areas in the market. But even in the most extreme markets there are a few. One area that I’m finding good value in is the mortgage REIT sector. In general this is a very misunderstood sector. I covered the basics of mortgage REITs in this post. Over the last few quarters the fear of rising interest rates has kept a lid on the values of the mortgage REITs with dividend yields remaining in the 12-19% range. So, I want to increase my coverage of the mortgage REIT sector, find the best values in the space, analyze the risks, and make some prudent investments.

I’ll share the process here on the blog.

I’m not the only one that thinks there is value in the mortgage REIT sector. The table below shows the return on equity outlook for the sector from Credit Suisse.

Returns for the mortgage REITs look pretty good well into 2013. Personally, I think the good times could last even longer but I think assuming returns remain solid through the end of 2012 is a good place to start. The main reason for the benign outlook for the sector is the assumption that interest rate increases, when they do come, will be gradual. The chart below shows the implied fed funds rate, from the futures market.

With a 2.5 year outlook of high return on equities for the sector means that the current dividend yields should be sustainable for that time. Meaning that for the next 2.5 years an investors can expect returns in the 12-19% from dividends alone. Not bad in the current environment, or in any environment for that matter. And given the current valuation of the sector I think an investor can expect some increase in valuation as well.

The mortgage REITs that I’ll focus on are those with market caps of greater than a $1B. Here is the list that I will be looking at.

In summary, I’ll be increasing my analysis of the mortgage REIT sector. I think there is some good value in the sector that merits consideration for an investment in the 2-3 year horizon. An investment in this sector would be a good part of a barbell strategy as I discussed here. With such high yields a small allocation to this sector can add some great return to the portfolio for little added risk. Stay tuned.