How to Invest in Real Estate The Conservative Way

As Investing Daily’s Jim Fink recently wrote in U.S. Housing Market Has Not Just Bottomed, the real-estate sector is fi­nally showing signs of life after having been one of the primary constraints on U.S. economic growth for several years.

While real estate is still a high-risk play, particularly as the U.S. economy remains weak, the current market environment offers attrac­tive entry points for more conserva­tive property plays that are “off the beaten path” in tech and finance. We’re not talking about homebuilders, folks!

The Tech Play

Ellie Mae (NYSE: ELLI) operates one of the largest electronic mort­gage origination networks in the US, providing software to the residential mortgage industry that’s geared to simplify processes.

The company’s main software product is its Encompass loan origi­nation platform, which can perform a variety of functions from docu­ment and compliance management to income verification and customer relationship management.

Although customers have the op­tion to license the entire platform, that can be an expensive proposi­tion. Because Ellie Mae caters pri­marily to small- and mid-sized op­erations that can’t always make that kind of investment, it recently began offering Encompass on a “Software as a Service” (SaaS) basis, whereby the software is provided to users via the Internet.

The flexibility provided by SaaS has enabled the company to make significant headway with small­er operations over the past couple years, boosting Encompass to nearly 30,000 users, while actually increasing revenue per user by 77 percent.

SaaS revenue increased 137 per­cent year over year to $8.4 million, or 40 percent of total company rev­enue. The remainder of Ellie Mae’s revenue comes from its mortgage origination network that connects originators, underwriters and in­vestors. Currently about 59,000 in­dustry professionals are part of the Ellie Mae network, with the com­pany getting paid on a per-transac­tion basis.

Since going public in 2008, the company’s earnings per share (EPS) have accelerated substantially, growing from just 5 cents in 2010 to 24 cents last year. EPS is forecast­ed to reach 44 cents this year and 62 cents next year. Although a fairly young company, Ellie Mae already has almost $30 million in cash on its balance sheet with solid cash flows and no debt whatsoever.

The company’s brisk growth should continue, as the real estate market improves and documentation and compliance requirements become increasingly onerous.

Land Grab

While you are likely familiar with the government-sponsored enter­prises (GSE) Fannie Mae and Fred­die Mac, you may not have heard of Federal Agricultural Mortgage Corp (NYSE: AGM), otherwise known as Farmer Mac.

Similar to Fannie and Freddie, which provide ample liquidity to the residential real estate market, Farmer Mac ensures that reason­ably priced financing is available to America’s farmers and rural communities, as well as to rural utility companies.

While Fannie Mae and Freddie Mac continue to struggle, Farm­er Mac has made a strong recovery over

the past few years. In the first quarter of 2012, EPS surged by 18.6 percent over the prior year, rising to $2.04 as net interest income jumped by almost a third.

Loan loss provisions have also been on the decline at Farmer Mac, as credit quality steadily improves. The 90-day delinquency rate across all of its assets has declined to just 0.44 percent.

Asset quality improvement has been largely driven by elevated ag­ricultural commodity prices—corn and wheat are currently trading near post-recession highs—and im­proving farmland valuations.

However, even as farmers’ fun­damentals have improved, Farmer Mac’s share price has failed to keep pace. The lender is currently trad­ing at just half its book value per share and just 7.2 times its forward 2012 earnings. As of the first quar­ter, it had $975 million in cash de­spite a market capitalization of only $272 million.

In addition to its attractive valu­ation, Farmer Mac also pays a 10- cent quarterly dividend. With a pay­out ratio of just 15.2 percent and plenty of cash on the books, the company is likely to raise its payout in the coming quarters.

 

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