Banking isn’t necessarily a complicated business. And I know this as former banker both in the U.S. and in other markets. You raise capital from shareholders. Then you raise additional cash from deposits and debt. And then you build a portfolio of assets made of loans and other interest-bearing securities.
The goal of a successful bank is to pay less on your liabilities that what you own on your assets. This is otherwise known as your net interest margin.
This, of course, is a moving target. Interest rates rise and fall both for short- and longer-term liabilities and deposits so successful banks need to constantly be working to limit the risk of paying more than what they’re earning.
And banks also need to make sure that their liabilities, depositors and lenders remain content to keep funding them. And at the same time, keep an eye like a hawk on the credit conditions and performance of their assets in their loans and securities.
There are many traditional banks in the market that are doing great jobs for their shareholders especially in the current improving banking market with normalizing interest rates and regulatory reforms.
But there’s another way to invest in the business of managing liabilities and assets that pay investors much more than the average bank stock. And the format of a real estate investment trust (REIT) makes for a better way to cash in for individual investors.
REITs are not just about buying properties and collecting rents. They can also invest in real estate loans and mortgages. The REIT structure provides the benefit of not having to pay corporate income tax on the company level by paying investors the majority of profits in dividend income.
And thanks to the Tax Cut & Jobs Act of 2017 (TCJA), dividends paid to shareholders also get a new tax advantage as 20% of dividends paid are deducted from their taxable distributed income. This makes the dividend that much more valuable for individual investors.
Mortgage REITs, when well managed like any good bank, provide investors with stable cash-generating loan assets with dividend income along with some potential for appreciation as the REITs build their company values.
Invest in New York Mortgage Trust
The first REIT to look at is New York Mortgage Trust (NYSE:NYMT). This REIT came to the public market in 2004 and made it successfully through the mortgage market mess of 2007-2008 and continued to attract additional capital in a series of additional share sales in 2014.
New York Mortgage Trust focuses on multi-family property mortgages and mortgage securities backed by multi-family properties. This continues to be a great market with sharply rising demand for residential units in major metropolitan markets in the U.S. And with rising rents, the underlying mortgages continue to be well defended by rising revenues for the underlying property assets.
In addition, multi-family properties tend to be more stable in their mortgages. For unlike single-family residences that will see families move — multi-family residences will see ownership remaining much more stable. This means that mortgages will be more stable in their cashflows with fewer prepayments due to fewer property sales. This helps the REIT to more easily forecast cashflows and better match up their assets and liabilities.
New York Mortgage Trust continues to expand its portfolio of loans. And revenues continue to advance with the trailing 12 months seeing revenue gains of 22.1%. And the REIT is run on a very efficient basis with the implied efficiency ratio of 31.3%, which means that it costs only 31.3 cents to earn each dollar of revenue.
And the spread between the interest cost of its liabilities and its interest-earning mortgages is at a healthy 3.3%. And while its return on assets is a tick less than average for a bank at 0.9%, the return on the equity of shareholders is a very healthy 12.6%.
The quarterly dividend of 20 cents provides a very nice yield of 13.1%. And the return for shareholders for the past ten years is a whopping 339.87% or an average annual equivalent of 15.96%.
And the best part is that you can buy this REIT at roughly its book value with a current stock price of $6.14 a share.
Another REIT Stock to Bank On
Then there’s my long-time favorite in the mortgage REITs that I’ve followed and recommended regularly for many years in MFA Financial (NYSE:MFA).
MFA is also in the mortgage market. But unlike New York Mortgage Trust, it invests in a variety of different types of underlying mortgage loans and related securities. This provides a bit more security of management’s ability to spread their invested assets across more and differing loan assets.
And it has done this very well. And even during the dark quarters of 2007 and 2008, the company remained profitable.
Its revenues have been a bit on the decline with a reduction in the liabilities and assets as the company has been defensive over the past year in managing its portfolio.
But the dividend paid quarterly remains constant at 20 cents providing a nice dividend yield of 10.28%.
Its return for shareholder over the past ten years has been 287.71% equating with an average annual equivalent of 14.50%.
And it is also a bargain right now with the shares trading around $7.77 making them valued at just a tick above the underlying book value of the REIT.
Neil George is the editor for Profitable Investing and by company policy does not have any current holdings in the securities mentioned above.