"What the wise man does in the beginning, the fool does in the end."
With eye-bulgingly huge yields, the mortgage REIT sector has become a true market darling. Yields such as Annaly Capital's (NYSE: NLY ) 14.4% or American Capital Agency's (Nasdaq: AGNC ) 20.1% have become too tempting for yield-starved investors in a near-zero interest rate world. And financial backers sponsoring IPOs have been rushing to market to take advantage of the opportunity.
According to The Wall Street Journal, seven of the nine real estate investment trusts that have filed for IPOs so far this year will invest in mortgage-backed securities. Those nine deals are looking to raise $2.6 billion in capital, the largest amount for mortgage REITs since 2009. Among the largest REIT IPOs are Pimco REIT, which is looking for $600 million, and American Capital Mortgage Investment, which seeks $500 million. These mortgage REITs cater specifically to retail investors.
And it's not just these new players who are out raising capital. The usual suspects have also been out hawking shares for fresh cash. Mortgage REITs invested in agency mortgage securities have scratched together some $6.6 billion in new cash since December. That includes players such as Annaly, which raised more than $1 billion. Recently, American Capital Agency and Invesco Mortgage Capital (NYSE: IVR ) also announced secondary offerings, pulling in more than a billion dollars combined. And American Capital Agency, Hatteras Financial (NYSE: HTS ) , and Chimera (NYSE: CIM ) have issued billions in new shares over the last few years.
A quick sample of the industry shows the high-yield allure:
|Two Harbors Investment (NYSE: TWO )
|Cypress Sharpridge (NYSE: CYS )
|American Capital Agency
|Invesco Mortgage Capital
Source: Capital IQ, a division of Standard & Poor's.
Mortgage REITs make their money by borrowing at short-term rates and buying long-dated mortgages, and pocketing the spread between the two. They then lever up their balance sheet in order to exploit that spread, as you can see in the table above. Those yields trounce most of what you can find in traditional REITs.
And yet, given the move into the space by new players and the capital raises by established companies, you have to wonder how long the party can continue. Eventually, this rivalry will force some desperate players to buy lower-quality investments. Still, the basic ingredients for these high-yielders do remain favorable for now: low short-term rates and even somewhat rising longer-term rates, as my colleague Dan Caplinger notes. And as long as those conditions sustain, it looks like the good times can still roll, and that's why I have Annaly in my own portfolio.
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