Insider Action at a REIT

 | Feb 21, 2013 | 11:00 AM EST  | Comments
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Filings with the Securities and Exchange Commission have disclosed that two insiders at Newcastle Investment (NCT) each purchased close to 100,000 shares of the company's stock at an average price of $10.48 in a public offering this month. Randal Nardone, who serves as the company's secretary, was one of the buyers. Nardone had previously bought shares at an average price of $9.35 in January and at $6.70 last July.

Newcastle is up 25% year to date and over 100% in the last year, and the current stock price is $11.20. Insider purchases, particularly when multiple insiders are buying the stock, are often seen as bullish signals. We believe that they at least serve as a sign of higher-than-average confidence in the company, since by buying more shares an insider increases his or her exposure to the company and therefore to company-specific risks, rather than diversifying, as economy theory would generally predict.

Newcastle is a $1.9 billion market cap real estate investment trust that invests in securities backed by mortgages and real estate assets. Real estate investment trusts receive favorable tax treatment that is conditional on returning a large portion of their taxable income to shareholders. Consequently, they often have high dividend yields. Newcastle, for example, has made dividend payments of $0.22 per share in the last two quarters; annualized, that makes for a 7.8% yield at current prices. In addition, the company has recently been increasing its dividend payments -- a year ago, it was paying only $0.15 per share each quarter -- and so there is the prospect of further increases.

Of course, given Newcastle's line of business, it's not surprising that it performed very poorly during the financial crisis (and would be expected to be vulnerable to any troubles in the real estate market in the future). Dividend payments are still significantly down from where they were in the mid-2000s ($0.72 per share for most of 2007), and even after the recent rally, the stock price is just getting back to where it was at the beginning of 2008. Of course, the S&P 500 isn't much above its levels from January 2008 either.

In statistical terms, Newcastle has a beta -- a coefficient that measures a stock's volatility relative to that of the overall market -- of 2.2. So while there is quite a bit of attractiveness from an income perspective, perhaps enough to overcome any macro concerns, investors should be aware of the downside risk and be sure not to expose too much of their portfolio to the real estate market (particularly if owned property, the value of which would also fall in a housing collapse, makes up a large share of their wealth).

High yields are common among REITs that invest in mortgage-backed securities. Annaly Capital Management (NLY) is one of the most popular names in the industry, and it offers a dividend yield of about 12% at current prices and dividend levels. Annaly has similar vulnerabilities, though its stock price dropped only about 30% during the financial crisis and has now fallen back to that same level rather than rally as Newcastle has. Peers such as American Capital Agency (AGNC) and NorthStar Realty Finance (NRF) might be good candidates as well.

Despite the high dividend payments, REITs that invest in mortgage-backed securities are not appropriate for all investors. If the risks are not too steep, however, then we certainly can't deny that dividend yields of up to 10% or even higher are quite attractive. As part of an income portfolio that also includes a number of defensive stocks with high yields -- such as megacap consumer staples or pharmaceutical companies -- they could make for good prospects.

Newcastle does have a lower yield than some of its peers, but since insiders are buying the stock even after a run-up in the price, the company may be seen as more likely to provide capital gains as well or at least less likely to encounter operating problems in the short run.

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