Looking Ahead: How Rising Real Estate Prices Can Improve Mortgage REIT Performance
Home prices are rising so rapidly in the United States that some are talking about another real estate bubble. While there is very little chance that this will happen right now (the necessary pieces of the puzzle are just not there), we are seeing house price appreciation and bidding wars similar to that of the 2004-2006 real estate bubble.
While mortgage real estate investment trusts (REITs) are primarily sensitive to fluctuations in interest rates, rising house prices are another benefit. How does this help businesses like Annaly Capital management (NYSE: NLY), New Residential (NYSE: NRZ), Where MFA Financial (NYSE: AMF)?
Home prices are rising at double-digit pace
According to the National Association of Realtors, there were just over one million homes for sale in the United States at the end of February, which is a record. As a result, the median home price increased 15.8% year over year. The S&P CoreLogic Case-Shiller Home Price Index recorded a gain of 10.4% in 2020. There is a huge imbalance between supply and demand in the single-family home market as professional investors compete against each other. with home buyers fleeing the cities.
While people will start to use terms like “bubble” whenever an asset price has a big gain, it helps to understand that such things are quite rare. Residential real estate bubbles occur every three or four generations (the previous one was in the 1920s), and they force all major players – investors, bankers and government – to believe that an asset is “special” and cannot. publication date. Memories of 2008 are too recent for this to really happen. Real estate prices rise as demand exceeds supply.
Mortgage REITs have a unique way to capitalize
Mortgage REITs are different from traditional REITs, so it makes sense to take a minute to understand the differences. Most traditional REITs follow a tenant / owner model, where a company builds an office building, apartment building, or shopping mall and rents the units to individual tenants. Mortgage REITs do not invest in real estate; they invest in real estate debt (ie mortgages). While traditional REITs generate rental income, mortgage REITs earn interest.
Thus, mortgage REITs exposed to unsecured government mortgages will benefit from rising house prices. Let’s take a closer look at the three I named above.
MFA Financial’s portfolio is primarily invested in Whole Residential Loans and Real Estate Owned (REO). The company owns approximately $ 250 million in property, following foreclosures. Single-family rental vehicles are all the rage right now, and home builders Lennar recently raised capital to buy existing homes, putting it in direct competition with 4 American houses for rent and Houses Invitation. These companies obtain rental income as well as an appreciation in the price of the assets.
While Annaly Capital invests primarily in mortgage-backed securities guaranteed by the US government, it also has a large portfolio of loans that are unsecured. As house prices rise, loan performance improves because borrowers are less likely to give up a property that is worth more than the mortgage owed. Second, these loans are carried on Annaly’s balance sheet at 75% of their face value, which means that increased refinancing activity will allow this discount to be realized quickly.
Another mortgage REIT that will benefit is New Residential, which has a large mortgage origination arm. New residential occupies a prominent place in the unskilled mortgage industry, which contains mortgages that are unsecured by the US government. These loans have higher rates than traditional government mortgages and are often made to professional real estate investors. This is another case where improving house prices will promote better credit performance. The new residential will also be benefit to a recent rule change for Fannie Mae and Freddie Mac, which will present a broader lending opportunity for the company.
While the earnings of mortgage REITs are largely influenced by changes in interest rates, these assets are at least somewhat sensitive to the underlying fundamentals of the real estate market. However, these companies mainly trade on their dividend yields and book values. In an environment where we are seeing rapidly rising house prices, REITs most exposed to residential credit risk will benefit the most. This means that new residential and AMF should fall into this category. That said, any mortgage REIT with real estate exposure will reap benefits.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.