Crexus: A REIT for More Aggressive Investors
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Annaly (NYSE: NLY), a manager of Agency guaranteed residential real estate assets, has been delivering strong dividends to investors through a very rough domestic economic cycle. Crexus (NYSE: CXS) distributes its earnings from assets backed by commercial loans. REITS, such as these, are an interesting investment alternative since income and dividend investors are a mainstay of any market cycle. It is wise for any investor, even those with a high risk tolerance to be invested in companies that offer dividend income. During a period of recovery, many investors look to take on a bit more risk. The shares of Annaly and Crexus will be impacted differently by the direction of the economy.
Annaly's portfolio of Agency guaranteed mortgage securities has been offering a high dividend yield to investors despite the economic conditions that have caused a housing market depression for the last four years. Annaly's ability to offer the yields is as a result of the corporate structure which allows Annaly to offer secured investments at the parent level and trade in non Agency guaranteed investments through its subsidiaries. Annaly's in house management of the portfolios has proved to be very adept at achieving profits from trading these securities and passing them along to investors. In the fourth quarter of last year mortgage backed securities and Agency debentures comprised 90% of the company's portfolio. Adjustable rate mortgage backed securities comprised of 9% of the portfolio with 1% LIBOR floating rate collateralized mortgage obligations making up the balance.
A number of factors have worked against Annaly being able to offer capital gains on its shares. Not the least of which is the nature of the REIT, which dictates that all net income must be distributed to investors in order for it to maintain its tax favored status. Additionally, the company has a shelf offering for 125 million shares to be issued at around $16.16 which will dilute the current float by at least 10%. The company has been able to offer a strong dividend and it is played by income investors and funds leading into the ex-dividend period by shorting the stock and buying it back at a reduced price to improve yield. The trading pattern of this company is quite predictable in that regard. Another factor that comes into play is the slow recovery in the U.S. and the crisis in Europe. Revenues at the year end of 2011 were down to $1.12 billion in comparison to $1.9 billion for the same period in 2010. Revenue growth year over year is negative in response to the aforementioned conditions.
Crexus reported increased net income in the fourth quarter of 2011 of $41.8 million compared to $4.5 million in the same period of 2010. Crexus owns loans or assets backed by commercial real estate debt. Commercial mortgages are viewed as having more risk than residential mortgages. With the risk come yields in excess of 12% compared to Annaly's annualized yield on average interest earning assets of 3.31% in the fourth quarter of 2011. Commercial REIT's typically have less debt as they borrow less money and use long-term yields. Commercial loans have no leverage, whereas residential loans can be leveraged up to eight times value.
The Federal Reserve has forecast that the economy will grow between 2.4 to 2.9% in 2012 up from its January estimates of 2.2 to 2.7%. It is also predicting that unemployment will be between 7.8 to 8% from its current three year low of 8.2%. The Fed also sees inflation slightly higher but below the set target of 2%. The Fed is still expecting interest rates to remain low until 2014. The Federal Reserve has also stated that if it demonstrates the need, the Fed will employ a third round of quantitative easing to boost the economy. A depressed housing market and a lack of a consensus on the national debt reduction are two main drawbacks to recovery.
Low short term rates have been the primary reason for yields on residential mortgage REITS. Any recovery above the anticipated rates will diminish the yields that Annaly has been able to achieve with its residential portfolios. Annaly is trading its portfolio with an eye to rates remaining low for the next two years. Likely, according to the Fed, there is at least another year of low short term rates to drive the returns on residential REITS.
Diminished yields, dilution of the share capital and lower net income have hit Annaly's share price in a predictable manner. All these negatives aside, the shares are trading near book value and investors continue to show confidence in Annaly's management to continue to deliver high yields in a risk adverse market. It is likely that the shares will trend downward, particularly into the ex-dividend period. It is also likely that yield will be cut based on the downward trend in net income. Still, for the risk adverse investor, Annaly's share price, yield and predictable trading pattern are a good fit. Other residential REITs such as Annaly's wholly owned subsidiary, Chimera has lowered its quarterly dividend in the first quarter 2012 to $0.11 from $0.17 a year ago. This decrease is a direct result of diminished net income. Another residential REIT to report diminished income in the first quarter of 2012 is Equity LifeStyle Properties which recorded $12.4 million in net income of $0.30 per share compared with $19 million of $0.61 per share in the first quarter of 2011. It is not shaping up to be a great year for residential REITs.
Crexus presents a different kind of investment for a different risk profile. Commercial REITS are reliant on better economic conditions to drive more demand and fewer vacancies for commercial space. Commercial REITS may be poised for a comeback if the domestic economy improves in the near to medium term. The performance of Taubman Centers (NYSE: TCO) a commercial REIT that specializes in shopping malls, is showing strong performance in the first quarter of 2012 with net income of $0.30 per share compared with $0.19 per share in the same period of 2011.
Crexus' investment in commercial mortgage debt and the external management of its portfolio add two levels of risk from Annaly. Crexus'stated objective is to provide long-term returns through dividends and capital appreciation. Crexus trades below its book value and pays a high dividend yield. The percentage of shares short is high and it is possible that the share price is at or near its bottom. It is a better situation for investors seeking capital appreciation. It is also a good bet for investors seeking dividend income. Between Annaly and Crexus, Crexus is the better stock for those who are pessimists with a mildly optimistic view. It provides some risk, therefore some rewards in terms of price appreciation and some income form of dividends. Annaly is a good investment during price dips for short to medium term safety and dividend yield. Crexus is a good investment for those investors willing to face higher risk.
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