Two REITs for Your IRA

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

You don’t have to be Donald Trump to invest in Real Estate! 

In 1960, Congress created REITs in order to give all investors the opportunity to invest in diversified portfolios of income-producing real estate.  As a result, you can invest in Real Estate similar to how you invest in companies: by purchasing shares of their stock. 

You can invest in anything from regional malls to shopping centers to apartments to mortgages to storage to lodging and resorts to office properties to natural resources – and everything in between.  You can even invest in health care REITs (but investing in health care REITs might not be a good idea with President Obama in office given his commitment to health-care reform).  

Armour Residential and New York Mortgage Trust

After a discussion with my pen pal Keegan last night, I investigated the REITs that we discussed and then narrowed it down to two: Armour Residential REIT (NYSE: ARR) and New York Mortgage Trust (NASDAQ: NYMT).  Admittedly, REITs had not shown up on my radar until this discussion.  In fact, the last time that I considered investing in them was during the financial crises when they got whacked.

Armour invests primarily in hybrid adjustable rate, adjustable rate and fixed rate residential mortgage backed securities issued or guaranteed by U.S. Government-chartered entities.  Similarly, New York Mortgage is a real estate investment trust in the business of acquiring, investing in, financing and managing primarily mortgage-related and, to a lesser extent, financial assets.  They both seem like reasonable bets.

These two companies are relatively small, have reasonable valuations, and are fairly comparable.  Armour is currently selling at around $7 per share and New York Mortgage Trust is not that far away from the $7 mark.  Both receive scores of 8 (out of 10) from MSN StockScouter.  And both of these REITs have forward P/E ratios that are slightly above 6, whopping dividend yields of around 16%, and significant top and bottom line growth.  The Fools, however, give New York Mortgage Trust 5 stars –  1 star more than Armour Residential.    

What Factors Should You Consider?

You should start by looking at the total return and then dig a little deeper and consider whether or not the company has demonstrated the ability to increase earnings, whether or not the company is conservatively leveraged, whether or not management has efficiently reinvested available cash flow, and whether or not the company has a solid operating strategy. 

Once you decide to pull the trigger, it is very important to monitor the company’s balance sheet as well as capital expenditures (aka portfolio enhancements).

How Should You Invest in REITs?

The consensus is that over the long run REITs deserve 5 – 15% of your investment portfolio.  The reasoning is sound: they are a good hedge against inflation, they have fairly low correlations to other asset classes, and they help diversify your sources of income.

REITs also make sense for your IRA because they pay out large dividends that are taxed as ordinary income.  That means that you get a special advantage from putting these in an IRA.  You do, however, need to ensure that you like the fundamentals of the REIT – and not just the big fat juicy dividend.

What About the Risks?

A major risk is that these are economically sensitive investments.  Both commercial real estate prices and REIT share prices have become more volatile.  Another risk is that determining entry and exit points seems to be a lot more difficult for REITs than it once was, particularly considering their surge in recent years.      

3 Reasons to Consider Investing in a REIT

  1. Diversification.  The variability of market returns over time underscores the importance of diversification.  Diversification is the key to long term investing success.  That means including investments from various sectors of the economy such as real estate.           
  2. Total Return.  REITs are required (according to U.S. tax rules) to distribute at least 90% of their taxable income to shareholders.  If past performance is indicative of future performance, you can also expect that approximately one-third of your total return will come from moderate, long-term growth in share price.         
  3. Risk / Reward.  Research has shown that adding REIT shares to your portfolio raises the efficient frontier, meaning that you can expect to realize higher returns on your portfolio while assuming less risk. 

My Foolish Take

Adding REITs to your portfolio makes sense.  Many investors love the fact that REITs pay monthly dividends.  But there are few REITs that I would feel comfortable purchasing even with a modest 5% of my resources.  Most REITs are just too small and therefore too difficult to adequately research.  The two REITs mentioned above, for instance, appear to have solid fundamentals and pay a very large dividend.  They are, however, very difficult to research given the dearth of reliable information available. 

RyanPeckyno has no position in any stocks mentioned. 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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