Real Estate Is a Bargain

Jake is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A Real Estate Investment Trust (REIT) is "any corporation, trust or association that acts as an investment agent specializing in real estate and real estate mortgages" according to U.S. Federal income tax law.

In layman's terms, this means a REIT is a company that owns and operates real estate, typically in the form of office buildings, retail stores, hospitals, warehouses, hotels and more. Being able to avoid part or all of their income tax liabilities, REITs are able to distribute large amounts of income to investors and we frequently see very high dividends making them a potentially very profitable investment.

Because their income is tied to the value of the land they hold REITs took an especially large hit during the 2008-2009 financial crisis, with the Dow Jones Equity REIT Index falling almost 70% and thus giving investors a bargain for future growth. And although not quite as drastic, another bargain on these real estate instruments has revealed itself as investors oversell.

REITs are a great investment right now. 

The first notable REIT that has been oversold recently is MorningStar's Exchange Traded Fund (ETF), the IShares FTSE EPRA/NAREIT Developed Real Estate Ex-US Index Fund (NASDAQ: IFGL) which has a portfolio of 170 different REITs.

These holdings amount to a total net asset value of $1.9 billion, mainly in the Greater Asia region (68%) followed by Europe (26%) and North America (6%). The high value of IFGL's assets makes it one of the largest REIT ETFs, but with a market capitalization of only $837 million it could be severely undervalued. According to Forbes, the Relative Strength Index (RSI) of IFGL is 29.95 officially giving the ETF the "oversold" title. Any stock with a reading of less than 30 is considered oversold according to the RSI. 

MorningStar's Credit Analysis ranks IFGL in the bottom 20% of REIT ETFs for price/prospective earnings ratio and price/book ratio, as well as in the top 20% of ETFs for a dividend yield giving investors 2.12%. These first two ratios indicate to investors that at the current price, IFGL is definitely a bargain.

The reason for this overselling is largely due to Boston's Windhaven Investment Management, an investment advisory firm which dropped its 29 million shares of IFGL, worth half the ETF's assets at $845 million. Windhaven refused contact from Dow Jones Newswires regarding the sale. Effectively this single event brought IFGL into oversold territory, giving investors the chance to buy low before the share price finds its equilibrium again.

The second stock is  a Real Estate Investment Trust instead of an ETF. Western Asset Mortgage Capital Corp(NYSE: WMC) is a brand new company, founded on May 11, 2012. At 6.19 WMC has a price/earnings ratio lower than 81% of peer companies in the real estate industry.

With a net asset value of more than 10 times its market cap, even its shareholders equity of $495 million eclipses the market cap of $433 million. This tells us right off the bat that WMC is a bargain because if the company were to liquidate and pay all liabilities, the cash left over would still be more than the market value the company is currently trading at.

In addition to the low market capitalization, WMC pays out a ridiculous 22.26% dividend. Even if investors don't realize that the stock is undervalued and the share price stays flat, you get a 22.26% return on your investment! 

For the cautious investor, there are also REITs whose real estate holdings are backed by government organizations such as Fannie Mae or Freddie Mac

MFA Financial (NYSE: MFA) operates mainly residential Agency Mortgage Backed Securities (Agency MBS). Agency MBS are MBS's which issued or guaranteed by a a federal or government agency. 56% of MFA's holdings are backed by either Fannie, Freddie or Ginnie Mae, and MFA is increasing this percentage every year.

MFA uses leverage and repo agreements to purchase its real estate holdings with spreads between the interest paid on loans and the interest received from renters, although the leverage is small at 3.1 times as of March 2013. MFA Financial offers a dividend yield of a cool 10.29%. MFA's market capitalization of $3.1 billion is significantly lower than its total asset value of $13.5 billion as well as shareholder's equity of $3.3 billion. According to Etrade, MFA's Price/Earnings (P/E) ratio is 10.27, which is lower than 74% of peer companies.

Conclusion

All three of these companies are trading far below their equity value, making them a bargain to investors, especially as we see a rebound in the housing market. If the market does not catch on and share prices remain stagnant, healthy dividend payments will make up for whatever income not gained.

Either way you slice it, REITs at their current prices can make very lucrative investments.


Jake Pompeo owns shares of IShares FTSE EPRA/NARIET Developed Real Estate Ex-US Index Fund. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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