With a deluge of positive economic data including ISM surveys,
better-than-expected advance third-quarter GDP numbers and a
surprising pickup in U.S. job growth in October - all braving the
much-hyped 'shutdown' - taper concerns have resurfaced.
'QE Taper' and 'rising interest rates' have become synonymous in
the market and fluctuation in interest rate regulates the fate of
the U.S. Real Estate Investment Trust (REIT) sector. This is
especially true in a high volatility corner of the market
known as the mortgage REIT or mREIT space (read:
A Comprehensive Guide to REIT ETFs
Mortgage REITs in Trouble?
mREITs generally use a short-term loan to purchase long-term
securities and generate revenues from the spread between the two.
Therefore, to make profits, these firms need a wide spread between
the short and long-term rates. These firms are typically
highly leveraged and more vulnerable to interest fluctuations than
most in the REIT world.
However, securities in this space boast some of the highest yields
in the equity market. This is because mREITs must pay out at least
90% of their earnings to holders for a favorable tax treatment.
Also, its leveraged nature makes it a high-yielding investment
Now that the U.S. economy has grown
in the third quarter - the highest this year - exceeding the
preceding quarter's growth rate of 2.5%, the possibility of the
Fed's QE taper came into the picture. Also, a high job growth
in October added to the speculation of a taper.
The commitment rate for 30-Year Fixed-Rate Mortgages that took a
breather following the 'taper hold' in late September, crept up 6
in early November on a week-over-week basis.
Notably, the rate has seen a steady run since April when it was low
at 3.45%. On the other hand, The U.S. 5-year treasury yield
rose to the highs of
(as of November 12, 2013) from the lows of 0.76% at the start of
If the scenario persists and short-term rates rise faster than the
medium-to-long term rates following tapering, the spread between
two will shrink thus hurting profit margins of mREIT companies.
Given this, investors should be at least a little concerned about
the current state of the mREIT ETF market. These funds might be
interesting short-candidates (or at least funds to avoid) for those
who believe a taper is coming, or a solid contrarian play for
investors who think that a reduction in QE isn't coming anytime
Mortgage REIT ETFs in Focus
iShares Mortgage Real Estate Capped ETF
It is one of the most popular mREIT ETFs in the market with about
$1.0 billion in AUM. Average trading volume of more than one
million shares a day also makes this fund liquid for investors. The
ETF tracks the FTSE NAREIT All Mortgage Capped Index and holds 34
securities in its basket.
With two companies, Annaly Capital Management (
) and American Capital Agency (
) occupying around 30% of total investment, REM bears high
concentration risk. Notably AGNC and NLY came out with poor
results this earnings season too, so they aren't exactly top REITs
to be in right now(read:
AGNC Earnings Report Crushes Mortgage REIT ETFs
The product charges investors 48 basis points a year in fees.
The dividend yield - the focus of the fund -was a robust 15.84% (as
of November 11, 2013). In last one-year period ending September 30,
2013, REM lost about 8.38% while in last three months it shed about
3.96% (as of November 11, 2013). REM currently carries a
Zacks ETF Rank #4 (Sell).
Market Vectors Mortgage REIT Income ETF
This fund follows the Market Vectors Global Mortgage REITs Index.
This one is an overlooked choice with just $93.6 million in AUM and
average volumes of about 90,000 shares per day. As compared to REM,
this is a bit cheaper option as investors need to spend 40 bps
annually for this fund.
Dividend yield is however noteworthy having paid 11.41% on November
11, 2013. In last one year ending September 30, 2013, REM lost
about 8.38% while in last three months it shed about 3.85% (as of
November 11, 2013).
Sooner or later, 'taper' is on the way and it will send the mREIT
sector on even more of a roller-coaster ride than what we have seen
so far. But even if the Fed's taper is not put into effect this
year, the uncertainty about the future course of the Fed's action
will likely keep interest rates and mortgage spreads volatile thus
affecting the results of mREIT ETFs.
In such a backdrop, risk tolerant investors might bank on the
aforementioned funds just to reap the benefits of dividend yields.
Otherwise, chances of capital appreciation in the near future look
feeble in this troubled corner of the market.
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AMER CAP AGENCY (AGNC): Free Stock Analysis
MKT VEC-MTGE RE (MORT): ETF Research Reports
ANNALY CAP MGMT (NLY): Free Stock Analysis
ISHARS-MTG RE (REM): ETF Research Reports
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