Profiting From QE2: Buy REITs

In my last post, I hinted at using QE2 to your advantage by investing in companies that benefit from a steepening yield curve. But I didn’t have time to get in to specifics. Which is what I’ll do right now, seeing that I have a couple of hours to spare at the Fort Lauderdale airport.

The Federal Reserve let the market know that it plans to keep short term interest rates at extremely low rates for the next few quarters (if not longer). Companies that can borrow short term, can do so at very low rates. So long as you have AA-rated collateral, you can borrow money at about 0.30% on a 30 day basis. If you plan to borrow for a longer term, you just need to keep “rolling” your loan every 30 days or so.

So if you can invest in a AA-rated bond that pays say 3% or 4% and borrow money at 0.30%, you’re going to profit from the spread. Do such bonds exist?

They do – they’re called Agency RMBS and they’re just large pools of single-family residential mortgages that are bundled together in to large multi-million dollar securities and guaranteed against default by a government sponsored agency such as Freddie Mac or Fannie Mae. They also yield about 3.75% or higher.

So you can borrow money at 0.30% and invest it at 3.75% and you’re guaranteed against loss of principle by a government agency! Sounds too good to be true? Well it gets better!

Companies that use this business model to make money are set up as REITs and pay out a hefty dividend to shareholders. Companies like Annaly Capital Management (NLY),  Hatteras Financial Corp (HTS), Cypress Sharpridge Investments (CYS) are mortgage REITs that are set up to do exactly this. And they all pay approximately 15% in dividends.

An RMBS is basically a bond and all bonds have 3 types of risk:

  1. Credit Risk
  2. Prepayment Risk
  3. Interest Risk

Companies which invest in Agency MBS don’t suffer from credit risk. If the borrower of the mortgage defaults, the government-sponsored agency just buys it back and you get your money back. There is no fear of loss of principle!

Prepayment risk is when the borrower pays off the loan early and returns your principle back to you. This usually happens in environments when interest rates are dropping and borrowers can refinance their mortgages at a lower rate. If you get your money back early, you need to reinvest the money, typically at a lower rate. Given that mortgage rates are so low and refinancing is much more difficult than it used to be, the risk of prepayment is limited. There are some always some prepayments though which occur as regular amortization of the loan. Some companies will calculate how much of their portfolio and try to enter forward contracts to purchase more RBMS and thus mitigate the prepayment risk. CYS is one company that does this.

The third and major risk is interest rate risk. As the cost of borrowing increases, the spread between borrowing and invests decreases. Your profit margins drop and are no longer able to make the kind of returns you’re used to. Again some companies hedge against this event, and incur some cost in doing so. But hedging maintains long-term predictability of cash flows and may be worth the drop in potential yield. Again CYS does this and it’s net spread after hedging is 2.55%. It also uses 7.5:1 leverage to maintain a $4.5 billion portfolio against $600 million equity position. When you earn a 2.55% spread and can leverage up 7.5%, that’s a whopping 19% yield! CYS has about a 17% dividend yield.

Disclosure: I bought a 33% position in CYS on Friday and am going to be buying more under $13.50.

Fed Launches QE2: How Does That Benefit Me?

The QE2 leaving Southhampton

The QE2 leaving Southampton

Today the Federal Reserve launched the highly anticipated QE2, announcing that it will buy $600 million of Treasuries in 2011 ($75 million per month). It will also continue to reinvest payments on its securities holdings which could bring the total capital injection closer to $1 trillion dollars.

I’m still waiting to see any evidence of  “Change You Can Believe In” and for the $8.5 trillion bailout to kick in and create jobs. But since Bernanke seems that it hasn’t been working too well, we’re going to do exactly the same thing that got us in to this mess – keep interest rates low and turn on the liquidity spigots!

One point of interest is these policies seem to benefit banks the most. Here’s an excerpt from an article on Yahoo! News:

Meanwhile, market watchers noted the Fed’s plan is to focus its QE2 purchasing power on the middle of the Treasury curve, i.e. securities from 2.5 years to 10 years. As a result, prices of shorter-term bonds rose while the price of the 30-year bond tumbled, sending its yield sharply higher.

So the real result of the Fed’s action today is a steepening of the yield curve, which most benefits (wait for it)…the banks. The ability to borrow from the Fed at effectively zero and then reinvest in “risk-free” Treasury securities at a higher yield is a huge reason why bank profits rebounded so quickly from the depths of the 2008-09 crisis.

Despite loads of evidence to the contrary (and very little lending) the Fed is effectively doubling down on its bet that boosting the banks’ balance sheets is the best way to revive the economy.

I can’t believe that this is the best policy to revive the economy. However, it definitely makes sense to align yourself with the Federal Reserve’s determined course of action. Seems like there are 2 things you should do:

  1. If you’re currently unemployed, find a job at a bank. Most banks are hiring like crazy. Bank of America has thousands of job postings (I’m not making this up)
  2. If you’re looking to invest, look for companies that benefit by borrowing at zero interest and reinvesting in risk-free Treasury or Treasury-like products.

There are several companies that fall in this category. Not only do they benefit from the current scenario, but they also pay high dividends and enjoy REIT status (meaning there’s no double taxation of profits) without actually investing directly in real estate.

Any guesses? I’ll talk about them in my next post.

$2,811 In Passive Income For April 2008

I was so busy in May that I completely forgot to post April’s passive income summary. On the bright side, April was a been a record breaking month for me with total “passive” income amounting to $2,811.42. On the flip side, I’ve been so busy, I haven’t been paying attention to my sites and May’s income will probably be lower.

If you recall, the income for March 2008 was $2, 667.18, so this is $144 jump is a 5.4% increase. However, one of my stocks is a Japanese REIT, and it paid out a quarterly dividend amounting to about $230, so the $140 increase isn’t a real increase – it’s going to disappear for May. Besides, the jump from February to March’s passive income was 11.9%, so this isn’t as good. (In case your wondering why I’ve invested in a Japanese REIT, here’s a good posts on why Japan’s real estate is a good investment.)

But so long as I can sustain it over $2,500 per month, I’ll be happy. Especially since I’m going to pursue my MBA full-time and I won’t be able to work.

Here’s the breakdown:

A new addition this month is the affiliate income I made from Ebay. In the past I’ve bought A LOT of gold coins on ebay. Since most of the gold coins are of a specific type, and I like to automate repetitive tasks, I used to have searches emailed to me on a regular basis. However, since I also like to try and monetize everything, I decided to set up a store to serve as both a place to aggregate my favorite searches and generate some affiliate income. Here’s my gold coin site, aptly called French Gold Coins. Check out the coins under the Recommended list – these are my favorite coins. The site is a .info site that I bought for $0.99 from GoDaddy and it was created using BANS. For a little more info, look at the 2nd half of this post. I also set up a site to aggregate news pertinent to Gold and Gold Coins, as another example of how to automate repetitive tasks.

Last month I mentioned that my Adsense revenue was dropping since I was being smart-priced. In an attempt to prevent that I modified the way Adsense shows up on the site – only search engine traffic sees Adsense now. Other traffic gets shown ADSAQ ads, which is helping compensate for Adsense’s lost revenue. February’s Adsense income was over $400 and has been dropping ever since. But I think I’ve figured out the issues and expect it to be pretty much constant at this level, or maybe slightly higher.

On the other hand, Linkworth has done really well on my sites. March’s income was almost double of February’s and as expected, April’s income was even higher. I’m very happy with their service and I strongly endorse it. It’s a good addition to Adsense, since it doesn’t conflict with their TOS (terms of service) and its always a good idea to have multiple streams of income. Incidentally, the only decent book EVER written by Robert G. Allen is Multiple Streams of Income: How to Generate a Lifetime of Unlimited Wealth!. All of his other books are crap, but surprisingly, this is one of my favorites!

Text-Link-Ads is also doing moderately okay although its taking more time than Linkworth. I think you may not allowed to use both of them on the same site, so see which one works better for you. Between the two, my favorite is currently Linkworth, for the obvious reason that it’s generating more revenue for me. 😀

Amazon affiliate income has started to pick up and hopefully it will continue as I learn more about affiliate marketing and try out different techniques to boost it.

In March, I made $60 from Domain Embarking, a site that helps you earn money from parked domains. Since they only pay out quarterly, I didn’t make squat from them, but I’ve added a couple more sites and have had a couple of people sign up using the affiliate link so I expect to make a little bit more in the next cycle. I expect to make more than enough money to pay for the registration fees and my hosting for all my sites through the income generated through Domain Embarking.

Prosper is still handing out $25 signup bonuses to new lenders and that program generated $175 in April. My total proper account value is now $2995 of which $800 is cash. I’ve been so busy I haven’t had time to invest that amount. I have my own criteria for investing in loans and it usually narrows my universe of investment-grade loans to under 20 at any given time. Of that half will ask loans for real estate projects which I don’t do and eventually they’re only 3 borrowers who I’ll think are worthy of lending money to. Here’s a good post on How Not To Bid On Prosper.

I also made around $1,151 from some oil investments and other dividends. Some of the stocks pay over 10% in annual dividends. Two of the oil investments are paying 15-18%. The third oil investment is currently barely producing, but that seems like it will improve over the next few months and boost that portion of my income too. Also, as the price of oil stays around $100 per barrel, the monthly payout (which is typically delayed by 3 months) will increase a little bit.

I also made about $128 in interest from savings and CDs. My gut feeling is that the Federal Reserve will probably keep the interest rates steady for the rest of the summer. However, even if they do drop the rates (I don’t think we’re going to see a rate hike for a year or two) it won’t make a very significant difference in my income. And I’ll probably be spending that money while I’m in college so I don’t have any expectations from it anyway.

I have some minimal expenses for domains and hosting. I pay about $119.40 for annual hosting on Dream Host. I had several periods of downtime last month and they did credit my account with an extra month. I like that they have one click installation for wordpress, php forum software, mysql databases and other stuff. I’ve used GoDaddy in the past and I didn’t like their interface at all, although I have heard it has improved. Dream Host is a lot easier to use in my opinion. If you use coupon code “PassiveIncome” you’ll get $19.40 off the annual fee or you can use “Dividends” to get free domain registration. I also pay around $60 for domain registrations which I usually register with 1 and 1. At $6.99, they’re pretty cheap. However I did go and register a bunch of domains for 99 cents so next year I’ll probably be paying close to $175. On a monthly basis, these costs will work out to roughly $25 (or they will once the domains go full price). GoDaddy currently has a promotion – .com domain transfers for only $6.99 and .info domains for only 99 cents.

As you can see, I have multiple streams of both online & offline income. My online income is generated from 10 different companies. The other income is produced from the dividends of about 10 different stocks and 3 oil investments. Having diversity is very important. Periodically, one of them will taper off (like adsense did), and not being too concentrated in it prevents your passive income totally disappearing.

Having any sort side income that sufficiently large to allow you to pay the rent and put food on the top is a great stress reliever. It also provides you F*** YOU money, in case you don’t see eye-to-eye with your boss or you feel that your job is sucking the life out of you! For stubborn and opinionated people, having F-U money is awesome!

I hope I’ve inspired all of you to try and boost your passive income or maybe add new sources to increase your current income streams.

Please let me know how you’re all doing.

Property Prices Correcting In India Too

Property prices in India have been on a tear for quite a while now. One of the condos I bought in Ahmedabad in 2006 doubled in just over a year. While the growth has been pretty tame since then, I was nonetheless quite surprised.

But in other parts of India the market has actually begun to correct. After the housing downturn of America, UK, Spain and Australia, it’s finally India’s turn to feel some pain. According to the Economic Times of India, prices are cooling down. The real estate prices in some cities have come down as much as 25%.

Land prices in the national capital region (NCR), Mumbai suburbs, Bangalore and Hyderabad have corrected by up to 25% as property developers slow down their land purchases. Poor sales and lower availability of credit at higher cost have prompted property developers to end the mad rush to acquire land. Some of the developers have even backed out of land deals which were agreed upon as the slowdown hit the sector.

Prices have come down by up to 25% in Mumbai’s distant suburbs, including Thane and Belapur, and pockets of Hyderabad and Bangalore, according to property consultancy firm Knight Frank India.

I think the reason why Ahmedabad shot up so fast between mid-2006 and mid-2007 might have been because it was declared a mega-city and thus suddenly popped up on everyone’s radar. Despite being invested in the market, I wasn’t entirely happy to see prices shoot up so much. I guess that was because we had paid cash – if I had been fully leveraged with 10% down, I might be singing another tune!

Regardless, property prices still seem exorbitantly high in many places in India. Hopefully the 25% correction will bring some much need relief to the average middle class family.

1st Carnvial of Dividends & Passive Income

Welcome to the very first edition of carnival of dividends and passive income.

I’m going to kick it it off with my own submission on How I Made $2,667 in Passive Income In March. Of course, if you’ve already read it, you can read about the Tax Benefits of Passive Income or about Earning Passive Income from Domains.

Dobromir presents Emerson Electric (EMR) Dividend Analysis posted at Create Rising Passive Income From Dividend Paying Stocks.

Geoff presents How did I make 5-figure Passive Income in 2007? posted at Wealth Monkeys.

Writers Coin presents Why I Quit One Source of Passive Income posted at The Writer’s Coin, saying, “Moral issues far outweighed the desire to make money by deleting emails”

Will presents Why I Still Love Real Estate Investing: Being A Landlord posted at Your Finish Rich Plan, saying, “I’m a sucker for passive income. My idea of financial freedom is that of rental and dividend income totaling roughly twice my expenses, leaving me free to pursue other interests (which may very well be other money-making ventures). That’s why despite everything that happened in the real estate market the past couple of years (or maybe because of it), I want to be a real estate investor, and more specifically, a landlord.”

The Dividend Guy presents Considering REITs In a Dividend Portfolio posted at The Dividend Guy Blog.

Tyler McKinna presents Dividend Growth Fund Stratgies Revealed posted at Dividend Money, saying, “An article outlining dividend growth investing strategies and how major mutual fund managers approach stock selection.”

KCLau presents How to Identify and Invest in the Hot Stocks of Tomorrow posted at KCLau’s Money Tips, saying, “A review of the book “Finding the Next Starbucks by Michael Moe””

Mark @ TheLocoMono presents Tracking Your Prosper Portfolio with Money Plus posted at Just Personal Finance, saying, “Using Money Plus to track your Prosper income can help you simplify your knowledge of how much money you are making and project your cash flow/growth.”

FIRE Getters presents Etrade’s Quickplan – Personalized & Easy Retirement Planning! posted at FIRE Finance.

Lulu presents Got My Repayments from Lending Club posted at How I Save

We end with an article about music and money, which not quite relevant, is still pretty good nonetheless. Jeremy Zongker presents All I Really Needed to Know About Managing Money I Learned From Music posted at Destroy Debt.

That concludes this edition. Submit your blog article to the next edition of Carnival of Dividends and Passive Income using the carnival submission form. The next edition of this carnival will be on the 7th of May, 2008.

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Investing In Japanese Real Estate

In a previous post I had mentioned that a Japanese REIT was going IPO. I was wondering how I could get in on the action. It seems like a good idea – the Dollar should weaken against the Yen and Japan’s Real Estate should appreciate after almost a decade and a half of stagnation.

It seems its rather more difficult than it is in the US. Unless you buying a stock that trades as an ADR, you need to open an account that allows you to purchase stocks on a foreign exchange. Luckily I had already an account with Interactive Brokers to buy Australian dollars which allows me to trade on the Tokyo Stock Exchange.

Unfortunately, there’s a 13 hour time difference and so the trades have to be placed in the evenings. Also its a little bit trickier than placing trades through a US online-trader and there’s no phone support [although there is online chatting] and the Tokyo Stock Exchange doesn’t really provide much information about the individual stocks.

Anyway, here’s a list of Japanese REITs that trade on the TSE. You’ll notice that they have codes instead of ticker symbols. Also their prices are listed in Yen which is currently around 118 yen to the US dollar but that fluctuates minute by minute!

Good luck!

3229 / JP3046460006 Nippon Commercial Investment Corporation.
3227 / JP3046450007 MID REIT, Inc.
3226 / JP3046440008 Nippon Accommodations Fund Inc.
8963 / JP3046190009 TGR Investment Inc.
8987 / JP3046420000 Japan Excellent, Inc.
8986 / JP3046410001 re-plus residential investment inc.
8985 / JP3046400002 Nippon Hotel Fund Investment Corporation
8980 / JP3046350009 LCP Investment Corporation
8984 / JP3046390005 BLife Investment Corporation
8983 / JP3046380006 Creed Office Investment Corporation
8982 / JP3046370007 Top REIT, Inc.
8981 / JP3046360008 Japan Hotel and Resort, Inc.
8978 / JP3046330001 Advance Residence Investment Corporation
8977 / JP3046320002 Hankyu REIT, Inc.
8976 / JP3046310003 DA Office Investment Corporation
8975 / JP3046300004 FC Residential Investment Corporation
8974 / JP3046290007 eASSET Investment Corporation
8973 / JP3046280008 Joint Reit Investment Corporation
8972 / JP3046270009 Kenedix Realty Investment Corporation
8970 / JP3046260000 Japan Single-residence REIT Inc.
8969 / JP3046250001 Prospect Residential Investment Corporation
8968 / JP3046240002 Fukuoka REIT Corporation
8967 / JP3046230003 Japan Logistics Fund, Inc.
8966 / JP3046220004 CRESCENDO Investment Corporation
8965 / JP3046210005 New City Residence Investment Corporation
8964 / JP3046200006 Frontier Real Estate Investment Corporation
8962 / JP3046180000 Nippon Residential Investment Corporation
8961 / JP3046170001 MORI TRUST Sogo Reit, Inc.
8960 / JP3045540006 United Urban Investment Corporation
8959 / JP3045530007 Nomura Real Estate Office Fund, Inc.
8958 / JP3044520009 Global One Real Estate Investment Corporation
8957 / JP3044510000 TOKYU REIT, Inc.
8956 / JP3041770003 Premier Investment Company
8955 / JP3040890000 Japan Prime Realty Investment Corporation
8954 / JP3040880001 ORIX JREIT Inc.
8953 / JP3039710003 Japan Retail Fund Investment Corporation
8952 / JP3027680002 Japan Real Estate Investment Corporation
8951 / JP3027670003 Nippon Building Fund Inc.