Log in to your brokerage account… Call your broker… Request a plan prospectus from your pension administrator… Jump online and review the holdings in your “target retirement” funds, ETFs, variable annuities…
Do whatever it takes to find out – today – how much exposure you have to real estate investment trusts (REITs), and mortgage REITs in particular.
Then get rid of as many of them as you can.
The Market Vectors Mortgage REIT ETF (MORT) is down 24% in less than five months. And a number of its components are down more than 30%.
But it’s going to get worse. A lot worse. And that’s why I’m issuing a warning, because practically every “properly diversified” portfolio in America cashes these REIT checks.
Many people depend on them.
This is dangerous, especially when two of the most widely held mortgage REITs also happen to be two of the worst.
To be sure, aside from the one (big) exception you’ll see today, a longtime high-yield darling is about to get crushed…
The REIT Spoiler
You can pin this one on the U.S. Federal Reserve, too…
Thanks largely to its pernicious tinkering of monetary policy – first via artificially low interest rates and then via direct injection of capital into the financial system to the tune of $85 billion per month of direct bond buying ($45 billion specifically spent on mortgage-backed securities) – the Fed has created an environment in which interest rates are destined to rise.
In fact, the mere mention by Ben Bernanke back in May that the Fed will soon “taper” its bond-buying program now has caused interest rates, as measured by the benchmark 10-year Treasury Note, to rise to their highest levels in more than two years.
With the biggest buyer moving out of the market, MBSs are sure to take a hit. Moreover, the pace of rate increase has been anything but subtle, with the 10-year yield spiking to 2.90% – a 40% jump in three months.
Because mortgage REITs generate income by essentially borrowing money at short-term rates and then investing in higher-yielding MBSs, any significant increase in the cost of borrowing can devastate mortgage REIT book value.
And they’re about to lose their safety net…
As the Fed has basically, and repeatedly, told the markets that tapering is a fait accompli, it means that the buyer of last resort for MBS is about to remove – or at least slowly pull back – the MBS safety net.
Adding more uncertainty to the mortgage REIT equation is so-called “agency risk.”
The current debate over the fate of mortgage-related agencies Fannie Mae and Freddie Mac, and the future limited role these embattled agencies could play in the MBS space, also has caused the smart money to jettison mortgage REITs.
Two of the worst mortgage REITs to own right now also happen to be two of the most widely held ones, and they are Annaly Capital Management Inc (NYSE: NLY-C) and Two Harbors Investment Corp. (NYSE: TWO).
In the case of Annaly, the fund invests primarily in MBSs guaranteed by Fannie and Freddie, so it’s little wonder why the exodus from this fund has sent NLY cascading some 25% over the past three months. As for Two Harbors, the spin-off of its equity-REIT Silver Bay Realty operations in May turned it into much more of a conventional MBS play. The market saw this, got spooked, and the result was a 20% smackdown over the last three months.
So, are there any REITs that still are okay to own these days? The short answer is yes…
The REIT Exception: Safe and “Substantial” Income
Vornado Realty Trust (NYSE: VNO) is a traditional REIT.
Unlike mortgage REITs, Vornado actually invests directly in prime real estate properties such as office buildings, and the rents from these properties are what Vornado uses to generate income for unitholders.
That income is substantial, as the company owns buildings in the best, highest-rent locations around the country, including economically vibrant New York City, San Francisco, and Washington, D.C.
Vornado doesn’t pay 10%-plus on your principal, of course, like NLY and TWO. It gives you something much more powerful: the ability to keep your principal, just in case you ever want your money back.
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