In A Low-Yield Market, Don't Fall For this Common Investment Trap

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In an ultra-low-yield market like this one, it's not surprising that we get a lot of questions from folks who are seeking high-yielding – but safe – income investments.

A recent note from Private Briefing subscriber Richard P. is a good example.

"Bill: I own a couple MREIT (Mortgage Real Estate Investment Trusts) stocks. They typically have very high dividend yields. Both of them are doing well (over 20% gain in core value), on top of the high dividends they pay.

"I have a few questions about them:

  • What are the risks in holding these kinds of stocks?
  • What economical shifts will affect them down the road?
  • How long should we hold onto them?
  • They seem too good to be true sometimes … are they?
  • Can you recommend particular MREITs based on the particular company's investments/risks/methodology?"

Great questions, Richard – you clearly put a lot of thought into this and we appreciate you sending them our way.

In fact, I suspect that lots of other income-seeking readers have similar questions.

To get you some answers, I turned to our own Martin Hutchinson, editor of the Permanent Wealth Investor, an advisory service that specializes in income-enhancing strategies.

At a recent Money Map Press strategic planning session. we found a quiet corner to talk this through on one of our breaks.

Here's what Martin had to say…

"Well, Bill, REITs in general are a very good idea right now," Martin said. "But I can't recommend mortgage REITs at this point in time. In fact, they're shaping up as a trap for investors."

It was a stunner of a statement – especially coming from a fairly circumspect guy like Martin. I told him that he just had to elaborate.

"I say that they're a trap for investors because their continued success depends upon [U.S. Federal Reserve Chairman] Ben Bernanke being glued to his seat," Martin said. "By that I mean that they make all their money by borrowing short and lending long. That's a recipe for disaster. When inflation returns, and rates start to shift, they're going to get clobbered – as will the investors who hold them."

But, as Martin said, he does like REITs. And there are two, in particular, that are worth a look.

The first is Omega Healthcare Investors Inc. (NYSE: OHI)

It's a company profiled in an article entitled "The Double Your Money Secret I Learned Over A Few Crab Cakes" that discussed the unseen power of dividends.

This well-run company focuses on a growth business here in the U.S. market – elder care.

"A lot of investors don't realize just how big an investment opportunity senior care really is," Martin said.

He's right. The nation's 90-and-older population nearly tripled over the past three decades, reaching 1.9 million in 2010, according to a joint report released late last year by the U.S. Census Bureau and the National Institute on Aging.

Because of increases in life expectancy at older ages, folks 90 and older now comprise 4.7% of the older population (age 65 and older), as compared with only 2.8% in 1980. By 2050, this share is likely to reach 10%.

Omega focuses on the higher-margin skilled-nursing-facilities market, where the company owns or holds mortgages on 432 properties run by 51 healthcare operators.

And, of course, there's that hefty dividend yield, which is what makes REITS like this one so attractive

Indeed, Omega Healthcare shares currently yield 7.8%. What's more, The company has raised its dividend in each of the last eight years.

If you want a more-conventional REIT, take a look at Agree Realty Corp. (NYSE: ADC), which owns a portfolio of retail outlets. It's up 15% (plus another 7% in dividend payments) since Martin recommended it back on Oct. 5, 2011, in a Private Briefing column that looked at investments with low debt loads.

Wall Street analysts have suddenly become intrigued by the stock, and have slapped on "Buy" recommendations and target prices as high as $30 (33% above where Martin recommended it).

"I like it because it's not-heavily levered," he said. "And it currently pays a 6.1% dividend yield."

Martin is always looking at ways to enhance those yields, and employs a number of those tricks for his subscribers in the Permanent Wealth Investor. Take a look at how he does it here.

But you still have to be careful.

"Like the subscriber said in his query, there are some yields that are literally too good to be true," Martin said. "That either means the company is paying out too much of its profits or cash flow to maintain the dividend, is employing some ill-advised financing strategy or is counting on the current-interest-rate anomaly to continue. None of those three can be maintained for long."

And you don't want to be the one who gets trapped.

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish… and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.

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  1. Dale | December 3, 2012

    Then tell me why so many instutional investors are in mReits, are they all stupid too, or do they just want the little guy out so they can make more?????????????????????????????????

    You keep talking about inflation, the way this country keeps adding debt, and taking more taxes, who is going to have all this money that will cause inflation???????????????????????????

    • BHOLMES1 | December 3, 2012

      Dale:

      We get that question about inflation here more frequently than anyone would ever imagine.

      We’ve talked about this at length in Private Briefing. But this is probably a good opportunity to discuss it here. There are probably a lot of folks who have the same question.

      Let me start by saying that you seem like a pretty informed guy. I mean that as a compliment. And you're asking questions — always a good thing. It means that you're thinking about what's being said here, and are thinking how that might affect you (and probably what you should be doing). Congratulations. That puts you ahead of about half of all retail investors.

      I say that in complete sincerity.

      Now let me answer your question about inflation … but allow me to begin by first posing a question to you.

      Do you realize that, before the current market gyrations (fueled by fiscal-cliff uncertainty), U.S. stocks had soared 11% on a year-to-date basis? In other words, from the end of December 2011, until they reached their peak in early October of this year, stocks (as measured by the Dow Jones) had risen by that double-digit amount …

      You and I both know that stocks are a discounting mechanism — that is, they are a reflection of expectations … expectations of improved future earnings, of hiring, of increased spending by consumers (who account for 70% of the economy), of an economy on the mend. That's particularly true of a period in which stocks advance 11% in just 10 months.

      So if we go back in time to late December of last year, and think about how we felt about things at that point, can you honestly say that you had such bullish expectations for the economy, for earnings, for hiring, etc.? I'm betting that a guy as informed as you are would say "No way."

      So why, then, did stocks rally so strongly in the face of such worry and such truly expectations?

      As you correctly pointed out in your comments … it was the government printing prices working in overdrive.

      Most folks think about inflation in very traditional terms … higher prices at the pump, at the prescription counter, in their son or daughter’s tuition bill. That’s inflation, to be sure.

      But it’s only one kind of inflation.

      And there’s another kind – called “asset inflation” – the rapid rise in prices of assets, either financial (like stocks) or hard assets (like gold or other commodities).

      Most folks refer to that kind of inflation as a “bubble.” But it’s still inflation, and it’s still incredibly damaging.

      When cheap money is created on a massive scale, it’s going to squeeze out somewhere – you can only contain it for so long.

      Remember the Asian contagion? Greenspan was in the process of raising interest rates when that came along. He had to turn on a dime and reverse course, slashing rates in a big way in very quick succession.

      Slashing rates is just another way of reducing the price of money … that’s what interest rates are … the price of money. Cutting rates like this makes money “cheaper” – if not just downright cheap.

      Easy money washed into the economy. And guess what? That led to two bubbles – two bouts of inflation. The first was the housing bubble, which we’re still paying for. The second was the dot-com boom … and subsequent bust.

      Go back through history, and you’ll see lots of these. Tulip Mania in Holland. The South Seas Bubble in Britain (which even clipped Sir Isaac Newton). The Crash of 29.

      All were due, at least in some part, to some form of cheap money, which then helped fuel a bubble (inflation) in asset prices of some sort. Most folks don’t view that as inflation … but it is … and, as a study of any of those events will show, it’s highly damaging inflation.

      One final point. Martin Hutchinson has repeatedly made the point to me that, once asset inflation takes hold, it’s fairly easy for it to spread to the consumer sector, too.

      That hasn’t happened so far. And let’s hope it doesn’t ….

      Hope that helps some, Dale.

      Please keep writing.

      William Patalon III
      Executive Editor
      Money Morning & Private Briefing

  2. Bart | December 3, 2012

    Actually, the thing to note here on mREITs is that it depends on Fed policy whether the will be risky, and they are. You just can't set and forget one as they are very interest sensitive, and not just based upon inflation policy. For now they are in vogue because the Fed has leant stability by stating it will keep rated low through 2014. But that can change and market rates effect value on these, too. Right now there is a risk of falling mREIT prices as rates have trended lower over time which means the same leverage used to generate returns cab't generate as much on the same amount of capital.

    • BHOLMES1 | December 3, 2012

      Bart …

      Excellent points … thanks for the contribution.

      Well done …

      William Patalon III
      Executive Editor
      Money Morning & Private Briefing

  3. sharon McCurry | December 3, 2012

    Great 411 on MLP and REIT's. Today
    is first time reading Hutchinson's column.
    It is practical and easy to read.
    Keep the column flowing with the green truth!

    • BHOLMES1 | December 4, 2012

      Dear Sharon:

      I'll make sure to pass along your kind words to Martin. Allow me to say "thank you" for him. I've worked with him for more than five years now and will tell you that he's as candid and principled as they come. He writes what he believes, and he writes what he knows, which is a lot.

      Martin was once a global merchant banker, and he's done some pretty remarkable things. He worked on both Wall Street and Fleet Street, and is a leading expert on the international financial markets. At Creditanstalt-Bankverein, he was a senior vice president in charge of the institution’s derivative operations, one of the most challenging units to run.

      But it was Martin’s work in Bulgaria,Croatia and Macedonia that has always impressed me most. In February 2000, as part of the Financial Services Volunteer Corps, Martin became an advisor to the Republic of Macedonia, working directly with Minister of Finance Nikola Gruevski (now that country’s prime minister).

      Macedonia had been staggered by the breakup of Yugoslavia – in which 800,000 Macedonians lost their life savings – and then the Kosovo War. Under Martin’s direction, the country issued 12-year bonds and created a market for the bonds to trade.

      The result: Macedonians were able to sell their bonds for cash, and many recouped more than three-quarters of what they’d lost – to the tune of about $1 billion.

      In other words, Martin fixed the finances … of an entire country.

      How many folks can say that? (We keep hoping that Washington will wise up and give him a ring … so far, hasn’t happened. I’m only half joking …).

      At some point, if you haven’t already … and if you really like Martin’s work … you might want to consider subscribing to one of our low-cost newsletters … Private Briefing comes out each day and the cost is about 26 cents a day. Money Map Report is $49 a year.

      Martin contributes heavily to both.

      In the meantime, please keep reading Money Morning. And by all means please keep writing to us. Let us know what you like, and what you’d like to see more of. We appreciated the time you took to post here.

      Here’s wishing you and your family a warm holiday season. And may good fortune follow you all the way through the New Year.

      Respectfully yours,

      William Patalon III
      Executive Editor
      Money Morning & Private Briefing

  4. Olaf | December 4, 2012

    Just use stochastic charts to see where any stock is headed, put in your stops, add and take profits regularly. No reason why you can't get in on a good thing while it's still good and get out when inflation hits and i rates go up. Then short it on the way down.

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