Its been a hell of a few weeks for mREITs. From the Friday freakou t just over one month ago to the recent week’s 5%+ price declines investors are digesting multiple new risks to the mREIT’s businesses. In response to all this valuations for the sector have come down to a level that represents a very positive risk reward setup.
First, lets outline the new perceived risks. Nobody has outlined it better than AGNC. In a recent investor presentation they stated:
Basically, all these new risks are very very small probabilities, i.e. tail risks. Many of these mREITs have come out publicly and commented on these risks, basically saying that they fears are overblown. Also, several of the mREITs have announced some big buybacks recently. Overall, the environment remains very positive for mREITs as I outlined in my post on Q2 mREIT earnings. At that time, valuation, P/B, for the mREITs I follow was 1.05. Lets look at the valuation now. Below is my new valuation table.
They key here is the Q3 2011 estimated book values. The Q3 estimated book values were pulled from various sources. What most investors are missing is that agency mREIT book values are going up in Q3, not down, driven by lower rates. Also, Q3 dividends remained strong with only a couple of reductions, nothing out of the ordinary. Valuation for these mREITs is now at a P/B value of 0.88 and the dividend level is up close to 19% for the sector. This is at the lower end of historical valuations. In particular Agency mREIT valuation is quite compelling. Stock prices have come down significantly. This combination presents a nice long setup. Yes, there are new potential risks on the horizon but the risks are small and prices have adjusted accordingly.
I’m playing this setup with options, selling slight out of the money puts and would be willing to go long the solid agency mREITs, NLY and AGNC in particular, if these levels continue. Also, I’m not taking full positions in the event prices continue to go lower. For more risk averse investors, wait until Q3 earnings are reported in a few weeks and listen to the CEO comments on the current environment. You probably won’t get the same level of prices but good value should persist for a while.