Writing for Barron’s this week, John Kimelman had some comments on my recommendation of mortgage REITs. (see “The Value in Non-Tech Nasdaq, Mortgage REITs” Subscription may be required.)
Here is an excerpt:
Regardless of market conditions, Wall Street has proven itself adept at coming up with arguments for why a heavy weighting in stocks is always a good bet.
The latest subgenre of the “stocks are forever” theme is the notion that the Nasdaq, now trading near its year-2000 high of 5000, isn’t the bubble it was 15 years ago because investors have somehow wised up in the intervening years…
Meanwhile, Charles Sizemore, who runs his own Dallas-based money management firm, Sizemore Capital Management, sees value right now in a sector long popular with Barron’s readers — mortgage real-estate investment trusts (“REITs”).
Unlike regular REITs, mortgage REITs don’t buy office buildings or malls. Instead, they invest in real-estate debt such as commercial and residential mortgage-backed securities.
“I wrote earlier this year that mortgage REITs as an asset class were trading at some of the steepest discounts to book value in history,” Sizemore writes. “Well, as we round out the first quarter, very little has changed on that front. Even as earnings and revised book values have come in, valuations haven’t changed much.
Sizemore, who invests in Mortgage REITs, points out that the sector is one of the few remaining truly high-yield corners of the market, and the top ten holdings of the iShares Mortgage Real Estate Capped ETF (REM) have a weighted average yield of 10.4%.
“But what interests me more are the large discounts to book value,” he adds. “The top ten holdings trade for 97 cents on the dollar. But Annaly Capital ( NLY ) and American Capital Agency (AGNC) trade at even deeper discounts, 81 cents and 83 cents on the dollar, respectively.”
As he puts it, “you could hypothetically buy up all of the shares and close the two mortgage REITs, selling their assets as spare parts, and still make a respectable profit of 19% and 17%, respectively.”
Kimelman correctly points out that I didn’t discuss in the article the risks involved with buying mortgage REITs, and he points out that rising short-term rates crimp their profitability. I do, however, discuss those risks in a prior piece and advocate that mortgage REITs mitigate this risk by pouring their cash into share repurchases rather than new mortgage securities at lower yields.
Charles Sizemore is the principal of Sizemore Capital Management. As of this writing, he had no position in any security mentioned.