Thanks to the improving job scenario and rebounding real estate sector in the U.S., the Federal Reserve recently announced that it could “consider” tapering off its monthly liquidity injections sooner than expected. While this may come as a shocker, I believe that this is a great time to buy REITs.
This is because in its press release, the Fed had stated that it will keep a close eye on the U.S. economic recovery. If all the key sectors continue to rebound, and unemployment rate falls below 7% during 2013, it “could” consider unwinding its quantitative easing over the next year. That is “not” specific by any means, and a lot is depending upon “ifs” and “buts.”
Furthermore, if the Fed pulls the plug on quantitative easing beforehand, liquidity from the economy will be siphoned off by the rising interest rates, which will eventually defeat the whole purpose of QE3 & QE4. In fact, an economic report recently suggested that a rise in interest rates is harmful for the U.S. economy (as interest repayments rise). Thus, it is highly unlikely that the Fed will terminate its stimulus package (soon).
However, the truth is that the market dynamics haven’t changed yet, and the Fed “will” continue to inject $85 billion in the U.S. economy every month, at least during 2013. But in this chaos, almost all REITs have witnessed a spurt of selling, which makes them attractive at the current valuations.
This REIT has a juicy dividend
In my opinion, Apollo Residential Mortgage Inc (NYSE:AMTG) is one of the best REITs out there. With a modest 53% payout ratio, Apollo’s dividend yield stands at a staggering 17.03%. And despite the recent crash in REITs, Apollo’s shares have actually risen fractionally over the last year.
The best thing about this REIT is that it enjoys exceptionally low CPRs, or Conditional Prepayment Rates. With low interest rates and ample liquidity in the U.S. economy, most REITs witnessed a surge in their CPRs. But, Apollo enjoys low prepayment risks because it primarily deals in affordable housing refinancing and has relatively lower exposure to mortgage backed securities.
For the recent quarter, Apollo Residential Mortgage Inc (NYSE:AMTG) posted an impressive CPR of 7%, which is significantly lower than most of its peers. Besides that, Apollo Residential Mortgage Inc (NYSE:AMTG) also enjoys an extremely high gross margin of 83.8%. With low prepayment risks, significant exposure to HARP, and high margins, Apollo Residential Mortgage Inc (NYSE:AMTG)dominates the industry with a high ROE of 21.6%. As a result, its operating cash flow has grown 161% over the last five years, which is faster than most of its peers.
A different story here
However, shares of American Capital Agency Corp. (NASDAQ:AGNC) are down nearly 20% over the last year. The REIT posted disappointing results in the previous quarter, which was followed by a consistent decline in its share prices. The main culprit for the decline was the sharp rise in interest rates.
With a debt/equity ratio of 5.96% and interest rates on the rise, one can casually deduce that American Capital is headed for a massive fall. But, the truth is that American Capital is a well diversified REIT. To counter the decline, its management recently announced that it has initiated short positions in Treasury bonds, which hedges out its portfolio to rising interest rates. Besides that, the REIT also reduced its exposure to 30-year bonds to limit its risks from rising interest rates, free-up capital, and to lower its leverage.