Eagle Eye Opener: Twist & Doubt… Will QE3 Weaken REIT Strength… Or Will Bernanke Keep Investors Dancing into the New Year?

With the Fed’s extension of Operation Twist through year’s end, real estate investment trust (REIT) investors can be confident that their plays will continue to pay off through 2012… But will they continue to be a strong investment in 2013, if the government stops doing the Twist? The simple answer is indicators suggest the situation could tilt either way. Here’s the reasoning…

Why REIT strength will continue: Operation Twist ensures a yield spread will exist between the interest rates of short-term loans (which REITs borrow from) and long-term loans (which REITs loan out). REITs then take the funds generated from the spread and leverage that up to 10x to bank the profits they then pay out to investors as dividends.

So, as long Bernanke and the boys keep on dancin’ the twist, REITs should continue to pay out close to the same level of dividends. And even if the Fed stops the music in 2013, it’s still committed to ZIRP (zero-interest-rate policy) through 2014, ensuring at least some level of spread will exist that REITs can use for dividend payments. Add to that good fundamentals recently reported in the U.S.housing market — boding well for REIT share prices – and investors can look forward to an appreciation in REITs. That is, as long as Americans keep buying homes.

Why REITs could weaken: At the same time the Fed’s twisting, it’s also flooding the market with funds from quantitative-easing part III (QE3). A consequence of QE3 is the flattening of all interest rates. When the dance stops, even though a spread is ensured through ZIRP, it could be squeezed down significantly, leading to dividend cuts from REITs. In fact, according to Seeking Alpha, some REITs are already feeling the pinch, as “Annaly Capital Management, Inc. (NLY) cut its dividend by 9% beginning with its Q3 dividend distribution… the fifth time in the last six quarters that Annaly cut its dividend.”

So, what’s the bottom line? With a continued strong housing market, REIT share prices should remain attractive. And, if the Fed continues its Chubby Checker impersonation — twisting its way through 2013 — REIT investors can look forward to consistent dividends. But if the Fed stops the dance in 2013, REIT investors may see their dividends dwindle…