A Bet on the U.S. Housing Recovery… with 15.5% Dividends

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.
Most of your Dividend Pro positions rose this past week, with one notable exception. You were stopped out of Spain’s Telefonica S.A. (TEF) as you hit your stop price of $15.00. But you also gained 35.9% on your sale of the September $17.50 call options, which mitigated your losses. That’s the power of this “forbidden strategy.” You can make profits even when a position moves against you. 
Although TEF now boasts a huge 11.4% yield, with the increased uncertainty surrounding Spain’s macroeconomic situation, I am not keeping it on the watchlist. 
This week’s Dividend Pro recommendation, Two Harbors Investment Corp. (TWO), boasts even a bigger yield than TEF — a whopping 15.5%. 
Two Harbors is a mortgage Real Estate Investment Trust (REIT) that invests in both agency (i.e., Freddie Mac and Fannie Mae) mortgage-backed securities and higher-risk, non-agency mortgage-backed securities.  
In the fourth quarter of 2011, the government-agency securities in Two Harbors’ portfolio had an average interest rate of 3.5%. The non-agency ones had an average interest rate of 9.7%. 
Two Harbors’ basic business model is to borrow money at roughly 1% and invest it in a portfolio of these bonds. It then levers them up at 4.5 to 1 to generate its high dividends. (Leverage of 4.5 to 1 means that the company invests $4.50 for every dollar it has under management.) Although REITs trying to balance these assets can be highly risky, I think Two Harbors is especially well-positioned to keep generating its high rates of return for the foreseeable future.
Here’s why…
First, according to CEO Tom Edwin Siering, the current interest rate environment is attractive for Two Harbors’ business. That’s largely due to the Fed recently announcing that it anticipates keeping the target federal funds rate low until at least late 2014. With borrowing costs low, Two Harbors’ interest rate spread can remain high.
Second, non-agency securities are having a strong year in 2012, with the ABX subprime index up about 17% towards the end of March. That means a big chunk of Two Harbors’ assets are becoming more valuable.
Finally, Two Harbors is now purchasing single family homes at a significant discount to replacement cost, and then renting them out for income. Note that this is the same strategy Warren Buffett recently endorsed when he said he’d buy up "a couple hundred thousand" single family homes if it were practical to do so. Sadly, he can’t, as Berkshire Hathaway (BRK-B) is just too darn big.
So buy Two Harbors Investment Corp. (TWO) at market today and place your stop at $9.60.

Portfolio Update

Seadrill (SDRL) soared 5.84% this past week. On April 12, 2012, Seadrill announced that it exercised an option to build a new tender rig at the COSCO Nantong Shipyard in China. Still trading below its 50-day moving average, SDRL remains a HOLD.
Hospitality Properties Trust (HPT) jumped 2.69% this past week.  This robust Real Estate Investment Trust (REIT) is now up 8.53% since my initial recommendation and remains a BUY.
Vanguard Natural Resources (VNR) ended the week 0.67% lower.  Still below its 50-day moving average, VNR remains a HOLD.
Global X Super Dividend Exchange Traded Fund (SDIV) rose 0.79% this past week.  Still trading under its 50-day moving average, it remains a HOLD.
P.S. Please join me for the Las Vegas Money Show, May 14-17, at Caesar’s Palace. To register, call 1-800/970-4355 and mention priority code 026655 or go to NicholasVardy.lasvegasmoneyshow.com. I also encourage you to sign up for my hedge fund seminar, Wednesday, May 16, 9 a.m. – 11 a.m.

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