In the hierarchy of half-truths, hoodwinks and practical jokes, there are lies, damn lies and then there are statistics. Somewhere within this hierarchy must also be NAR press releases.

According to the NAR, which just released its new home sales statistics for February, the supply of homes in the U.S. dropped 3 percent at the end of last month to just over 4 million homes. This translates into an approximately 9.6-month inventory of new homes, compared to about 10.2 months at the end of January. In addition, the NAR says the national median existing-home price for all housing types was $195,900 in February, down almost 10 percent from 12 months ago.

Some, including the NAR, are suggesting that this decline in inventories, a rise in existing home sales, and the almost 10% drop in the median house price may be signaling an end to our national housing malaise. In reality, prices still need to correct – and substantially - before we see an end to this housing implosion.

Unfortunately, median home prices remain far too high relative to incomes, and no amount of optimistic NAR press releases can obscure that fact. In this case, a picture truly is worth a thousand words, because the NAR’s own data convincingly tells the story:

In almost twenty years, the NAR “Affordability Index” has never shown such a disconnect from the NAR’s own calculation of U.S. median home prices. As sub prime lending took off, this disconnect grew even more pronounced. Clearly, bathing under the comforting salve of easy money, the ebullient housing market was able to easily shake off stagnant wage growth.

Now that the credit spigot has been all but shut off, and wages are coming under pressure from an almost certain recession, housing prices – even at current levels - cannot be sustained. In fact, it looks like they have much further to drop. NAR economists are undoubtedly already working over-time to unearth a fresh silver lining for next month’s press release, and judging by their own data, they will need their most creative minds.

Back in 2005, executives at Camden Property Trust (CPT), a REIT specializing in large apartment complexes, were worried. Why had they been unable to maintain their average occupancies at historical levels? They fanned out across the country to talk with CPT property managers, who complained of having to turn down the credit of applicants for $700 a month apartments when home lenders across the street were providing the same questionable applicants with mortgages worth $350,000.

The CPT executives were suspicious about the mortgage credit checks, but they were unable to confirm their hunch. Numerous observers had been monitoring the record growth in the U.S. homeownership rate, including the Boston Globe which published a 2005 article entitled The Dark Side of Subprime Loans. The article was suspicious about “so-called subprime loans” but until the cracks in that market began to appear last spring, there was no way to know for sure what was happening.

What everyone could see, however, was that the U.S. rate of homeownership had reached historically high levels. It was at about that time that both outgoing Fed Chairman Alan Greenspan and incoming Fed Chairman Ben Bernanke both played down the possibility of a so-called “housing bubble”. As it turned out, there was a bubble, encouraged not only by subprime mortages, but also by numerous government policies that encouraged homeownership.

Not surprisingly, the same census data that showed increasing rates of homeownership also showed increasing levels of vacancies in the nation’s rental unit housing stock. Although still higher than average, the national vacancy rate was far outpaced by above average vacancy rates in the Midwest, where homeownership is more much more affordable and economic dislocations have put pressure on the region generally.

While policy makers across the U.S. crowed about delivering the American Dream to ever greater percentages of Americans, the problem for CPT was more immediate: how do we keep our apartments full so we can grow our earnings? CPT, like many apartment owners, had no choice but to reduce their average rents, offer incentives to renew leases, ask for smaller deposits to protect against property damages, and reduce investments in capital improvements. Cumulatively however, these solutions were not much more than a band-aid in the face of a national stampede to homeownership.

Subprime was not the only reason for the increased levels of homeownership. Well-meaning government sponsored loan programs allowed first time home buyers to purchase homes with little or no equity, and tax laws allowed the deduction of home mortgage interest while providing generous shelters for capital gains. At the same time that the subprime market was starting to unravel however, influential law makers were also rethinking the government’s largesse.

In a New York Times article entitled “Mortgage Trouble Clouds Homeownership Dream”, Representative Barney Frank (D) Massachusetts said that United States policies in recent years had promoted the idea of homeownership too hard and at the expense of rental housing. “I wish people could own more homes,” he said in the interview. “But I also wish I could eat and not gain weight.”

Many academicians agreed. In the same article, Joseph E. Gyourko, Professor of Real Estate and Finance at University of Pennsylvania’s Wharton School of Business asserted that "we went too far. It’s not the case that high homeownership is always good.”

These increasing homeownership trends are clearly reversing, and now may be the best time in years to own Apartment REITs. Not only are secular, long-term demographics supporting improved operating fundamentals, but the havoc in the financial markets has discounted all REIT stocks.

REIT stock prices have typically been a good harbinger of property values. When they trade at or below the value of the underlying real estate, as most are now, they have traditionally predicted weakening property values. However, these times are anything but traditional, and commercial property values now are not directly connected to the wider real estate contagion because they produce reliable monthly income.

These income streams determine how commercial property is priced, and the income for apartment buildings looks strong for several reasons. First, commercial development of new-builds in this cycle has been muted by high construction costs. This limited new supply, combined with strong growth in demand from immigration and the “echo-boomers”, should provide a floor under apartment rents. Add in the thousands of households now returning to the rental pool, and apartment fundamentals have never looked more solid.

In addition to these strong operating fundamentals, the Fed has responded to the liquidity crisis by directly intervening in the government agency securities market. I wrote about this unconventional and rarely used Fed operation in a previous article, which was undertaken in an effort to reduce long term borrowing rates. This Fed action, along with its steep reductions in the discount rate, will also help support commercial property prices.

So far, values have held up. The Mortgage Bankers Association reports that in 2007, defaults in Fannie Mae loans for apartment buildings remained flat at .08%, while 2007 defaults among apartment loans sponsored by Freddie Mac declined to .02%. In fact, despite all the bad news in residential real estate, defaults in the broader commercial property sector remain at historical lows. According to the Wall Street Journal, the delinquency rate on the almost $840 billion in outstanding commercial mortgage backed securities is less than .5%. Lenders, particularly Fannie Mae and Freddie Mac, also remain active in the apartment sector, unlike other commercial property markets where liquidity has dried up.

In this market, making a REIT investment of any kind isn't for the faint of heart, but other well run, diversified apartment REITs worth considering include Avalon Bay Properties (AVB), which has a large development pipeline in high barrier markets and low leverage, and Essex Property Trust (ESS), which also operates in high barrier markets and just announced an almost 10% increase in its dividend. Avoid AIMCO (AIV) which operates in low barrier markets like the Midwest and has relatively higher leverage, and REITs like Post Properties (PSS) which had been relying on condo conversions to drive operating results.

Caveats? A deep recession will impact rents no matter how strong the fundamentals. The “shadow” rental market of foreclosed homes will also put some pressure on apartments, but rental homes do not compete directly with apartments. Most renters are not interested in mowing lawns and shoveling snow, and apartment living excuses them from these kinds of responsibilities.

Also, REITS enjoy favorable taxation treatment at the corporate level, so most do not allow for the 15% tax treatment on dividend income. Accordingly, if you decide to do any buying, it should be done in your 401k or IRA. Consider REITs for capital gains though, and think of the dividends simply as the icing on your subprime cake. Click here for a complete Apartment REIT list, including current yields

Disclosure: None

The world, once awash with levered up Greenspan housing dollars chasing assets of almost any kind, is now drowning in debt. In response, Bernanke's beleaguered Fed dramatically announced another cut in its discount rate late on a Sunday afternoon, just minutes after rapidly orchestrating and ultimately approving the sale of Bear Stearns (BSC) to J.P. Morgan Chase (JPM) for just $2 a share. Working in concert, The Fed and the Treasury Department accomplished these two unusual feats while most traders and bankers cowered under the cover of Friday’s closing bell.

In bailing out Bear Stearns, the Fed invoked parts of a rarely used law that allows it to lend directly to non-bank financial companies. Underscoring the seriousness of such a move, using the provisions under that law required a nod from at least five of the seven Fed Governors before the bailout could be implemented: the purposeful goal being to put a solution firmly in place before markets opened in Asia later on Sunday evening.

In a previous article, I noted the speech that then Fed Governor Bernanke gave to the National Economists Club in 2002, acknowledging the potential widespread detrimental effects of asset deflation to our economy. At the time, he said that the chances of widespread deflation in our economy were remote for two principal reasons. The first was “the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow”.

He noted that the second and “particularly" important factor was “the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape”. With the fallout in home prices striking squarely at the heart of the U.S. consumer, and financial institutions worldwide reeling from the effects of financial over indulgence, neither is any longer true.

This move, and a widely anticipated cut in the discount rate of at least another 50 basis points on Tuesday, underlines uncertainty at the Fed over the magnitude of losses that will ultimately arise out of the US credit bust, the effect on consumers and questions over the real health of our financial institutions, all areas critical to avoiding the “years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors” described in Bernanke’s speech.

Ironically, this drama could wind up being the beginning of the end of the credit crisis. Our ever-wise policymakers will now finally be forced to recognize the need to preserve the health US financial system, one of the two primary bulwarks against the widespread detrimental effects of asset deflation outlined by Bernanke in 2002. A failure the size of Bear Stearns would simply have been cataclysmic to our financial system and national well being.

Unfortunately, while I would never be cynical enough to suggest that the political hazard of not being re-elected trumps the moral hazard of rewarding excessive risk, in this election year I would be very surprised if we tax payers were not drafted into a government-sponsored bailout of our financial system that will ultimately be larger and more far reaching than anything previously seen in the S&L crisis. Anyone care for a PIK toggle?

As the British comedian Douglas Adams once wryly noted, “Nothing travels faster than light, with the possible exception of bad news, which follows its own rules”. Indeed, the bad news careening through the financial services industry has now permeated every corner of the market, forcing even the once impermeable Bear Stearns (BSC) into a government-sponsored survival suit.

The well-publicized crisis in the mortgage market has by now forced write downs and write offs of anything that is mortgage related, never mind the near bankruptcy of Bear Stearns. Even once sacrosanct “agency mortgage securities”, those mortgages guaranteed by quasi-governmental Fannie Mae (FNM) and Freddie Mac (FRE) are trading at a discount.

For those prescient few who saw this coming, 2007 was a year to position for a correction. There are two primary ways to position for a downturn, and Northstar Realty Finance (NRF), an internally managed Mortgage REIT that invests only in prime commercial mortgages, took them both.

The first is to maintain deal flow but slow asset growth by underwriting only to the highest standards with the best sponsors and at appropriate and rational risk/reward levels. Thus, through deliberately prudent underwriting, Northstar intentionally reduced direct originations of real estate debt in 2007 by almost 50%, down from 74 new loans in 2006 to just 41 in 2007.

The second is to strengthen the balance sheet and raise cash. Northstar, in essence, went long on cheap liabilities. The Company entered into a new $600 million term loan facility, mitigating the mark to market risk that has been hammering REIT investments) based on credit spread movements and interest rate fluctuations, and sold $135 million in loan exposure, at par, which returned equity and reduced future funding commitments.

While not directly impacting the Company’s liquidity except through increased management fees, in February of 2007, NRF also launched N Star IX, an $800 million CDO, which is the ninth in its “N Star” series of managed CDOs. The N Star managed CDOs are absolutely beautiful things to behold from a credit perspective: the aggregate upgrade/downgrade ratio is a stunning 25:1

In addition to Northstar’s managed CDO’s, the Company has directly issued approximately $4 billion of term financing via its own CDOs. If Northstar’s managed CDOs are absolutely beautiful to behold, Northstar’s issued CDOs are pure gold, and Northstar is about to take it all to the bank.

Not only have these issued CDOs never experienced a downgrade and continue to perform as expected, but 15 classes of notes have actually been upgraded. Most importantly for shareholders, these CDOs are in their reinvestment period. This means that as the loans inside the CDOs mature and pay off, Northstar can reinvest the proceeds at vastly improved spreads over their average cost of funds, which have been locked in at about a 50 basis point spread over swaps. Northstar has almost complete discretion in determining how and when to reinvest these funds.

While the company says it is difficult to determine exactly how much capital may be recycled due to performance-related extension options, approximately $427 million of NRF’s funded loan commitments have their initial maturity date in 2008. This is an enormous advantage in an environment where the capital markets have virtually shut down, cutting off capital intensive REITs from the fuel they must have to grow earnings.

Because the current lending environment is so constrained, the terms on which NRF can invest these recycled proceeds have also improved dramatically. The market for floating rate loans, which make up almost 90% NRF’s portfolio, has increased from LIBOR plus 250-350 bps in 2006 to LIBOR plus approximately 400-550 bps today (depending on term, structure and LTV). These vastly improved spreads will flow directly to earnings as the capital is reinvested.

NRF also indicated its intention to monetize the above-book value of its healthcare and net lease portfolios in 2008. This will allow NRF another opportunity to recycle cash into higher yielding investments and boost its historically strong ROE of over 20% (net).

As of year-end, the Company’s careful underwriting has resulted in strong credit performance with no credit losses and no non-performing assets not only in the "N Star" CDO series, but also across the entire $7.4 billion managed asset base. Northstar has consistently grown its Adjusted Funds From Operations and dividend, which increased 19% and 12%, respectively, over 2006 results. Northstar, which has no direct exposure to the single family housing market and subprime mortgages, pursues a match funding strategy and finances its assets in long term, non-recourse financing vehicles that eliminate mark to market risk.

With a .36/share dividend declared in the fourth quarter, Mr. Market has priced the stock to yield in excess of 19%. While 2008 will undoubtedly bring more challenges and there is considerable uncertainty generally, NRF’s historically strong performance and 19% yield would seem to compensate even the most adventurous investor pretty well.

Click here for a Mortgage REIT list, including current yields



Disclosure: Long NRF at the time of publication

mortgage reits, reits, reit

REITWrecks: March 11, 2008

Investing in REITs is not for the faint of heart these days. Write-downs are easier to come by than cheap commissions, and huge losses are more common than ice cubes in a fresh cocktail. And while you may need a cocktail if you own any of these stocks, calculating GAAP book value for these REITs will definitely cause any sober accountant to reach for the liquor cabinet.

Nevertheless, it pays to understand the confusion, as there are tremendous opportunities being created by the maelstrom in REIT Stocks. Some of the confusion is being aided and abetted by the by the Financial Accounting Standards Board, the folks who create our beloved Generally Accepted Accounting Principles (GAAP). They recently developed FAS 159 to help reduce this confusion, and it is being implemented as of this quarter by many REITs.

FAS 159 was designed to provide a more accurate picture of the real economic value of investments in debt and equity securities, the very lifeblood of real estate investment trusts. It permits eligible entities to measure many financial instruments at fair value – not just assets but liabilities too. FAS 159 will apply to many types of liabilities, but in the REIT world it will have particular relevance to CDO liabilities and corporate REIT debt.

As every reader knows, cheap, long-term, non-recourse CDO financings were the financial equivalent of pouring gasoline onto the credit bubble inferno in the first half of this decade. As every reader also knows, investing in a CDO is now about as popular as halitosis, and CDO assets have been marked down as fast as the accountants can sharpen their pencils

However, until the implementation of FAS 159 this quarter, Mortgage REITs which had issued CDOs were required to mark down the value of the CDO assets but were unable to mark down the value of the paired liabilities. This really didn’t make any sense: after all, if the assets were being marked down on one side of the balance sheet by the investors, why was the issuer still obligated to carry the paired debt obligation at full value on the other side? The same logic held true for the corporate debt of equity REITs

FAS 159 does not provide the perfect measure of a REIT’s economic book value, and not all CDOs are created equal (some have varying levels of recourse that could, in some circumstances, impair the equity interests beyond the value of the original investment), but it does address some important issues in the REIT Wrecks world.

In the case of Redwood Trust (RWT), pre FAS 159 accounting caused the REIT to report a net loss of $1.1 billion and a negative net book value of $22.18 per share as of year end. That’s right, negative. A full $1 billion of the net loss was attributed to the write down of its Acadia CDO assets. Most tellingly, the net loss attributed to Acadia vastly exceeded RWT's $118 million net investment in the Acadia CDOs. This accounting convention completely distorts the real economic value of the transactions and RWT's business propositions going forward: since RWT's credit risk is limited soley to its own equity interests, it is difficult to comprehend how the REIT could lose more than its original investment.

Implementing FAS 159 at RWT results in a positive, and more accurate, book value of $23.18. This is a huge swing and illustrates not only the importance of the new accounting standard, but also the folly of relying purely on GAAP. RWT's results have been clouded by these huge GAAP write downs and net losses, which do not correlate to actual economic value. I also believe RWT is extremely well managed, and the stock deserves a close look by any investor interested in this space.

Another great example of FAS 159’s impact is Alesco Financial (AFN). Upon the adoption of FAS 159, AFN expects to add approximately $2.7 billion, or $45.03 per share, to stockholders equity. Much of that comes from writing down the liabilities paired with its accident-prone Kleros CDO assets. The investors in these CDO assets have absolutely no recourse to AFN, and therefore AFN’s exposure to Kleros is limited to its net investment. Alesco has all sorts of other more serious trouble, and were it not for that, the Kleros CDOs would be nothing more than a public relations problem. FAS 159 won’t help that, but it will help investors assess the true economic value of AFN and many other REITs in a more realistic manner.

Click here for a Mortgage REIT list, including current yields.



mortgage reits, reits, reit

Disclosure: None

Note to Readers: This updates the previous related post Fixing The Mortgage Mess: an Old Twist?, which was written just before the Fed actually Twisted.

Historians say that if we are unable to learn from the past, we are condemned to repeat it. Economists, who study the dismal science, may simply believe that we are condemned. While I hold those who study these two influential and important social science disciplines in great respect, I like to embrace a more sanguine view.

Consequently, when I heard bond guru Bill Gross of PIMCO briefly mention a so-called “Operation Twist” last week, I was intrigued. The original Operation Twist was developed by the U.S. Treasury in 1961 in order to lower long term borrowing rates, in an effort to encourage investment and grow the economy, while simultaneously raising short-term rates to reduce pressure on the dollar. Essentially, it was an effort to purposely invert the yield curve. Thus the ''twist'' in Operation Twist. Part of the operation involved direct intervention in the market for residential mortgages.

Today, the Fed announced a similar, albeit incremental form of intervention in response to the astounding and rapidly evolving meltdown in the housing market. In response, the dollar soared and there is now some hope that the costs of longer-term borrowing will be reduced.

Why it took so long is hard to fathom. Thornburg Mortgage, a non-agency mortgage lender to prime, credit-worthy borrowers is struggling for its very existence. Even agency mortgage securities, those guaranteed by Freddie Mac and Fannie Mae, once thought to be one step removed from the federal government itself, are trading at distressed levels.

Doubt in the markets about the viability of formerly sacrosanct “government agency” entities to fulfill their financial obligations has caused huge dislocations in the capital markets. The correction of the housing bubble has clearly reached levels that policy makers did not previously imagine, and tremendous asset deflation is shaking markets worldwide.

In a 2002 speech to the National Economists Club, Ben Bernanke, then a Governor on the Federal Reserve Board, pointed out that the consequences of asset deflation were dire, highly destructive, and involved “years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors.”

In an effort to avoid this, he said then that he believed one of the primary options available to the Fed was the option “to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association)” in order to prevent the widespread detrimental effects of asset deflation.

In 1961, Operation Twist involved the Fed operating directly in the long term securities markets with the express purpose of lowering long term borrowing costs, including mortgage costs, to ignite economic growth. Hence, there is historical precedent for this recent Fed move, and hopefully it’s not too late to avert the dire consequences Ben Bernanke described in 2002.

Click here for a Mortgage REIT list

Historians say that if we are unable to learn from the past, we are condemned to repeat it. Economists, who study the dismal science, may simply believe that we are condemned. While I hold those who study these two influential and important social science disciplines in great respect, I like to embrace a more sanguine view.

Consequently, when I heard bond guru Bill Gross of PIMCO briefly mention a so-called “Operation Twist”, conceived and executed by the US Treasury in 1961, I was intrigued. The original Operation Twist was developed in response to the need to lower long term borrowing rates, in order to encourage investment and grow the economy, while at the same time raising short-term rates to reduce downward pressure on the dollar. Essentially, it was an effort to purposely invert the yield curve. Thus the ''twist'' in Operation Twist.

A similar form of intervention is now being discussed in response to the astounding and rapidly evolving meltdown in the residential and commercial mortgage markets. Thornburg Mortgage, a non-agency mortgage lender to prime, credit-worthy borrowers is now struggling for its very existence. Even agency mortgage securities, those guaranteed by Freddie Mac and Fannie Mae, once thought to be one step removed from the federal government itself, are trading at distressed levels – if they trade at all.

As a consequence, the average weekly mortgage rate for a 30 year fixed-rate mortgage increased by over 50 basis points between February 4th and February 28th. This came in spite of the Fed's back to back short term rate cuts 0f 1.25% in January, the most aggressive rate cuts in years, and the market's widespread belief that the key rate will be cut yet again at the Fed's next meeting on March 18th.

This lack of confidencein non-agency and even agency mortgage securities is causing interest rates to increase rapidly on home mortgages at a time when the economy and the housing market can scarcely afford it. In turn, this is putting further downward pressure on home prices. Put quite simply, as mortgage costs increase, the amount of home that people can afford to buy decreases. So they offer less, and the negative value feedback loop continues.

By all indications, this asset dislocation appears to be of historic proportions. Doubt in the markets about the viability of formerly sacrosanct “government agency” entities to fulfill their financial obligations is causing huge dislocations in the capital markets. Entire tracts of our financial system are at risk, and the continued health of our economy is hanging in the balance. The correction of the housing bubble has clearly reached levels that policy makers did not previously imagine, and tremendous asset deflation is happening now.

In a 2002 speech to the National Economists Club, Ben Bernanke, then a Governor on the Federal Reserve Board, pointed out that the consequences of asset deflation were dire, not unknown, and involved “years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors.”

In an effort to avoid this, he said then that he believed one of the primary options available to the Fed was the option “to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association)” in order to prevent the widespread detrimental effects of asset deflation.

in 1961, Operation Twist involved the Fed operating directly in the long term securities markets with the express purpose of lowering long term borrowing costs, including mortgage costs, in order to prevent asset deflation. Hence, there is historical precedent for this, and I believe the Fed needs to step in again and offer financing for residential and commercial mortgage securities either directly or through its newly expanded Term Auction Facility, and soon.

Those who hold the levers of power have contemplated and studied just such a scenario, and now it is time to act. If not, we tax payers ought to seriously question the wisdom of the policy makers in whom we have entrusted our national well being.

Click here for an updated Mortgage REIT list, including current yields

"In this environment, the current market price of assets has become disconnected from their underlying recoverable value."


Larry Goldstone, Chief Executive Officer, Thornburg Mortgage REIT
New York Stock Exchange: TMA

Click here for an updated Mortgage REIT list, including current yields

In this bountiful era of REIT wreckage, with liquidity having virtually disappeared from the mortgage market, the auction rate securities market, and last week, even the municipal bond market, it is helpful to be reminded of the irrationality that can sometimes rule daily trading gyrations.

According to Warren Buffett, Ben Graham said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market. Without fail, Mr. Market appears daily and names a price at which he will either buy your stock or sell you his.

At times he feels euphoric. When in that mood, he sets a very high price for your stock because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead. On these occasions he will set a very low price for your stock, since he is terrified that you will try to unload your stocks on him, bringing him immediate losses.

Mr. Market has another endearing characteristic: He doesn't mind being ignored. Consequently, Graham said, you must heed one warning: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful.

In my opinion, Mr. Market - always fallible and never perfect - is now being blind-sided by mark to market accounting. The non-cash charges resulting from these “mark to market” write downs are causing our servant Mr. Market to see nothing but trouble ahead for business and the world. Thus, he is setting a very low price for REITs and many other financial stocks, and that is creating opportunities.

In a different post, I will add more fascinating detail on the rigors of the Other Comprehensive Income account found on the balance sheet of most Mortgage REITs. For now however, suffice it to say, this is the magic "now you see it now, you don't" account for charges not affecting the income statement, because these charges are non-cash and in many cases, NOT permanent.

Furthermore, in the absence of a market for the securities held by many Mortgage REITs, most portfolio managers must use the CMBX and ABX indices to mark their portfolios to the market. As Fitch Ratings pointed out last month, the CMBX is currently indicating a default rate that is four times anything ever seen in the history of the CMBS market. So, managers must mark their portfolios to values that do not correlate with anything even close to actual performance. Does that seem rational?

Unfortunately, for REITs that are highly leveraged, these marks can also lead to margin calls which cannot be ignored – hence the aerial somersaults being performed by the funding desk at Thornburg Mortgage this week (with a perfect triple twist).

While Thornburg may yet make it (Larry Goldstone is clearly very talented and well-regarded), there are a number of well run, much less risky Mortgage REITs in the REIT Wrecks universe that Mr. Market has put on sale.

Companies such as NRF have funded nearly all of their assets on a long-term, non-recourse basis and are not subject to margin calls. They have cash available to reinvest in a vastly improved (less competitive) lending environment. Mr. Market is literally giving these stocks away, offering yields in the high teens and low twenties. Other attractive REIT stocks include NLY and AGNC.

The catch? You must be able to ignore Mr. Market while you push the button and buy from him. Let him serve you, not guide you.

Click here for an updated Mortgage REIT list, including current yields


Disclosure: REIT Wrecks owns NRF at the time of publication

Update: More detailed information on how the "Other Comprehensive Income" account works can be found in this post on REIT Accounting.