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Because the company remains fundamentally sound, we view this recent sell-off as a buying opportunity. The commercial real estate market remains buoyant and bears little resemblance to the weakening residential sector. For starters, most commercial mortgage REITs like Gramercy don't originate or invest in subprime residential mortgages. Instead, they focus on commercial loans and mortgage-backed securities, where default rates remain stable.

Mortgage REITs earn profits by borrowing money at a cheap rate and then loaning or investing at a higher rate. When rising interest rates push borrowing costs higher, profits get squeezed. While many of Gramercy's peers were hurt by shrinking interest rate spreads, GKK continued to prosper, largely because it originates most of its loans and therefore has more control over the terms.

Management has clearly demonstrated its ability to grow its asset base in a rising interest rate environment. In fact, the company nearly doubled its asset base last year and maintained a huge spread of 3.9% between its borrowing costs and lending income. That's well above the industry average of 2.2%. As a result, earnings climbed +43% last year, and shareholders enjoyed a whopping +39% dividend increase.

Going forward, we expect more of the same -- but we do have some reservations. A slowing U.S. economy could affect profitability, especially since recent efforts to match higher loan yields with higher borrowing costs forced management to resort to lower-quality loans. As a result, about half of the company's loan portfolio is backed by lower-quality (but still investment-grade) loans. These loans could have an adverse impact on results if commercial real estate loses value in a slowing economy.

That said, earnings are expected to continue growing at a healthy double-digit rate both this year and next. The company also recently bought a package of property leases, and rental income from these properties should contribute a stable source of revenue.

Action To Take --->  Mortgage REITs are high-risk/high-reward investments, but GKK is one of the more successful firms in the sector. With a P/E of about 11 times next year's projected earnings and an above-average yield of 6.7%, the stock is attractively priced right now.

Good investing!

Carla Pasternak
Editor
High-Yield Investing
http://www.StreetAuthority.com

Carla has been employed in the investment industry for more than two decades. In addition to her work as a writer for several other nationally recognized financial publishers, her previous experience includes a position as President of a well-respected investor relations firm. She has also been writing shareholder reports for public companies (annual reports, speeches, corporate profiles, slide shows, etc.) since 1980.

A highly successful investment analyst, Carla specializes in high-yield, income-paying stocks. In that pursuit, she's always mindful to select companies that not only pay rich dividends, but that also have the potential to deliver strong long-term capital gains.

On the educational front, Carla holds both MBA and Ph.D. degrees. When she's not watching the market, she's teaching business courses at the college level and managing several million dollars in portfolio assets.

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