Reits investing mortgages
Source: Annaly Capital Management While it may sound like commercial mREITs are thus safer than residential mREITs which is generally true if interest rates rise , keep in mind that this is a highly complex industry and there are always tradeoffs. For example, agency-backed MBS is a highly liquid, high-quality tier 1 capital market, meaning that mREITs can usually enter or exit trades very easily.
In other words, commercial mREITs usually operate in class, or tier 3, illiquid loans, which are harder to value. This means that commercial mREITs face the risk of having to write down the value of their assets more abruptly, which can hurt book value and can send the share price falling. Or to put it another way, residential mREITs are more interest rate sensitive, while commercial mREITs have potentially more volatile book value and share prices over time; especially if a recession hits and default rates rise on their underlying loans.
In addition to all this complexity associated with the underlying business model, investors need to consider the track records of individual mREITs. And even if mREIT management teams are capable of navigating a potentially more challenging rate environment, keep in mind that all mREITs are variable pay dividend securities.
This means much higher share price volatility. However, if you have a low to medium risk tolerance, desire very consistent income, and might need to sell shares to support your lifestyle such as in retirement , then mREITs are almost definitely not for you. One final risk factor to discuss is something I touched on earlier, internal versus external management.
The good news is that external management can cost less for the company because the asset manager assumes the back office cost of running a staff, including underwriters, researchers, and risk managers. In addition, an mREIT sponsored by a giant asset manager can have far more connections to potential clients and be able to put together more lucrative and larger deals than smaller, internally managed mREITs.
But external management comes with two big potential downsides: less ability to achieve economies of scale, and potential conflicts of interest with shareholders. Under this scenario, its profitability and ability to sustain and even grow its dividend over time will also increase. And if the mREIT grows its assets 10x or even x in size? This brings up the final risk with externally managed mREITs, the potential for conflicts of interest with shareholders.
For example, an mREIT may be trading at below book value, meaning that raising equity growth capital is guaranteed to destroy shareholder value and likely lead to falling dividends over time. However, by selling more shares and investing the money in more loans, the asset size grows, along with management fees. In this way, some poorly run externally managed mortgage REITs operate as private equity funds with management working for its own benefits, with little or no care for how long-term shareholders make out.
With so much complexity built into these things, and the risks to both share price and dividend so high, is it possible to successfully invest in this industry at all? The answer is yes; however it requires a lot of risk tolerance acceptance of share price, and dividend volatility , a hands-on approach keeping careful watch on key metrics , and very careful selection of which mortgage REITs you invest in. As with investing in any company, the ultimate deciding factor is due diligence, with special focus on the quality and trustworthiness of management.
And because mREITs, like their eREIT cousins, are legally required to payout almost all profits as dividends, growth must come from either debt or equity capital markets. In other words, mREITs always have fresh capital flowing into them to grow their assets over time even internally managed ones. Thus the trend in book value per share over time will tell you how well management is able to allocate this new shareholder capital.
This tells you how safe a dividend is and in the ultra-high-yield world of mortgage REITs, the safety rather than growth of the dividend is paramount, since the sky-high payout is really the only reason to own these things. As you can see, the company fallen short of covering its payout some years, which has resulted in numerous dividend cuts over this period.
In recent years many financial companies have been under stress from low net interest spreads, meaning the difference between borrowing costs and how much they can lend at. For example, Annaly Capital is trying to evolve beyond its residential mREIT roots to become a major player in commercial real estate, as well as middle market lending. Often viewed as a distinct asset class from equity REITs which own, operate, and collect rent on real estate properties, mortgage REITs function more like a lending bank by originating and investing in interest-bearing real estate debt instruments.
After a wave of dividend cuts in early , mortgage REITs have regained their footing over the past two years, and despite the tough macro environment in early , dividend increases have continued to outpace dividend cuts. Mortgage REITs now pay an average yield of Non-agency mREITs invest in RMBS and other types of residential credit that are not guaranteed by a GSE, including mortgage servicing rights MSRs and whole mortgage loans, which bear higher levels of credit risk but tend to be less sensitive to interest rates.
Commercial mREITs can also be further segmented into two categories: pure Balance Sheet Lenders, which originate and purchase loans for their own balance sheet, and Conduit Lenders, which originate and purchase loans both to hold on their own balance sheet and also for the purposes of securitizing the loans into a CMBS or other vehicle.
Hoya Capital Despite their volatility over the past several years, mortgage REITs don't deserve their "ugly duckling" status within the REIT sector and we reiterate our view that maintaining a modest mREIT allocation within a balanced real estate portfolio can be a prudent strategy to hedge interest rate and inflation risk while adding immediate income. Like more traditional banks, while rising rates negatively impact book values - declines that mostly remain unrealized "paper losses" in normal market environments - margin spreads and earnings power tend to improve with rising rates.
Mortgage REITs typically operate with a high degree of leverage to amplify investment spreads and often use short-term hedging instruments to manage interest rate and credit exposure, which makes each REIT rather unique in its end-exposure to certain macroeconomic environments. Mortgage REITs exhibit a high degree of correlation with high-yield corporate credit and tend to perform their best in "boring markets" - periods of lower interest rate and stock market volatility.
Below, we define the five primary risk exposures faced by these different types of mortgage REITs: leverage risk, credit risk, interest rate risk, prepayment risk, and derivative risk. Sector stalwarts Annaly Capital and AGNC Investment both reported double-digit declines in BVPS, but the softness was offset by better-than-expected EPS metrics, and each described a "significantly improved" future investment outlook given the higher rate environment.
Hoya Capital Looking more broadly at the macro environment, as the Federal Reserve intended , rising mortgage rates have indeed cooled the red-hot housing market in recent months. The recent cooldown has renewed the perennial "Bubble" calls from pundits , but fundamentals suggest that national housing markets are instead more likely to see a somewhat "boring" return to normalcy ahead similar to when rising mortgage rates resulted in a notable near-term slowdown in buying activity before the historic acceleration seen over the subsequent two years.
Importantly, subprime loans and adjustable-rate mortgages - the dynamite that led to a cascading financial market collapse in - have been essentially non-existent throughout this cycle. Commercial mREITs weren't facing the same "existential crisis" as their residential mREIT peers, but the sector's exposure to the hotel, office, and retail sectors dragged on performance early in the pandemic. Rent collection rates across these commercial sectors fully normalized by mid and the office, multifamily, and retail sectors have seen some of the strongest acceleration in same-store metrics over the past several quarters.
The pandemic-driven wave of dividend cuts gave way to a similar power wave of dividend hikes over the past 12 months.
FX SPREAD BETTING EXPLAINED FURTHER CROSSWORD
When looking to invest in this type of REIT, one should consider several factors before jumping in. For instance, the best apartment markets tend to be where home affordability is low relative to the rest of the country. In places like New York and Los Angeles, the high cost of single homes forces more people to rent, which drives up the price landlords can charge each month. As a result, the biggest residential REITs tend to focus on large urban centers.
Within a specific market, investors should look for population and job growth. Generally, when there is a net inflow of people to a city, it's because jobs are readily available and the economy is growing. A falling vacancy rate coupled with rising rents is a sign that demand is improving.
As long as the apartment supply in a particular market remains low and demand continues to rise, residential REITs should do well. As with all companies, those with the strongest balance sheets and the most available capital normally do the best. Healthcare REITs invest in the real estate of hospitals, medical centers, nursing facilities, and retirement homes.
The success of this real estate is directly tied to the healthcare system. A majority of the operators of these facilities rely on occupancy fees, Medicare and Medicaid reimbursements as well as private pay. As long as the funding of healthcare is a question mark, so are healthcare REITs. Things you should look for in a healthcare REIT include a diversified group of customers as well as investments in a number of different property types.
Focus is good to an extent but so is spreading your risk. Generally, an increase in the demand for healthcare services which should happen with an aging population is good for healthcare real estate. Therefore, in addition to customer and property-type diversification, look for companies whose healthcare experience is significant, whose balance sheets are strong, and whose access to low-cost capital is high.
They receive rental income from tenants who have usually signed long-term leases. Four questions come to mind for anyone interested in investing in an office REIT. What is the state of the economy and how high is the unemployment rate?
What are vacancy rates like? How is the area in which the REIT invests doing economically? How much capital does it have for acquisitions? Try to find REITs that invest in economic strongholds. It's better to own a bunch of average buildings in Washington, D. The best known but not necessarily the greatest investments are Fannie Mae and Freddie Mac.
They are government-sponsored enterprises that buy mortgages on the secondary market. Just because this type of REIT invests in mortgages instead of equity doesn't mean it comes without risks. An increase in interest rates would translate into a decrease in mortgage REIT book values, driving stock prices lower. In addition, mortgage REITs get a considerable amount of their capital through secured and unsecured debt offerings. Should interest rates rise, future financing will be more expensive, reducing the value of a portfolio of loans.
In a low-interest-rate environment with the prospect of rising rates, most mortgage REITs trade at a discount to net asset value per share. The trick is finding the right one. REITs are true total-return investments. They provide high dividend yields along with moderate long-term capital appreciation.
Look for companies that have done a good job historically at providing both. Unlike traditional real estate, many REITs are traded on stock exchanges. You get the diversification real estate provides without being locked in long-term. Liquidity matters. Depreciation tends to overstate an investment's decline in property value. This is defined as net income less the sale of any property in a given year and depreciation.
Simply take the dividend per share and divide it by the FFO per share. The higher the yield the better. The fundamentals of each are detailed below. The securities are comprised of groups of loans packaged together and sold as securities with payment guaranties provided by the federal government through Fannie Mae, Freddie Mac and Ginny Mae. While there is little default risk associated with these securities, there is significant on-going interest rate risk. Non-Agency MBS are groups of whole loans packaged together by credit profile and securitized.
These MBS are not guaranteed by the federal government. Non-agency MBS may either be a group of whole loans originated and packaged by the REIT itself or may be originated and securitized by another party and acquired on the secondary market.
Whole loans may be packaged into securities and sold in tranches according to underwritten credit profiles or they may be held on the REITs balance sheet. The above are just a few of the common components of a residential mREIT portfolio, there are many ways for REITs to invest in residential mortgages, including subclasses of each of the above, and participation with other lenders on large loans or securities.
Commercial mREITs Commercial mREITs generate income by lending on income producing commercial real estate through mezzanine financing, construction loans, whole loans and a variety of other securities. There are three primary means of acquiring assets as a commercial mREIT: Acquiring MBS originated and securitized by other lenders on exchange markets.
Conduit lending, which involves originating, packaging and then selling loans through securities such as CMBS. Types of investments made by commercial mREITs through the channels listed above include the following: Commercial Mortgage Backed Securities CMBS are loans that are originated, packaged then sold in tranches based on the risk profile of the underlying assets.
CMBS are collateralized by commercial real estate assets. Mezzanine Financing and Preferred Equity are riskier forms of commercial real estate lending but tend to generate greater returns. The mREIT contributes equity or debt in exchange for a preferred rate of return which is traditionally more in line with equity returns, than debt returns.
Commercial Whole Loans are similar to residential whole loans, they may either be held as balance sheet loans or securitized and sold. Whole loans may also be sold on the fourth market between institutions without securitization. Residential mREITs have generated an
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