The mortgage REIT or mREIT space witnessed a sharp rally compared to the S&P Index, during the second quarter, driven by regulatory relief, lower rates and a stable Agency mortgage-backed securities (MBS) market.
Notably, mREITs took a beating during the steep sell-off in March with companies witnessing drastic decline in share prices and book values. The economic and financial impacts of the coronavirus crisis resulted in significant dislocations in the mortgage and credit markets, flared up volatility as well as resulted in a liquidity freeze across the mortgage market.
What’s Driving the Rebound in the mREIT Space?
The Federal Reserve has been undertaking concerted efforts like purchasing Agency MBS to provide support to mortgage lending and housing markets and to improve functioning of the general financial markets.
This has ensued stability in the Agency MBS market. Moreover, in order to support the U.S. economy during the current virus-induced slowdown, the Federal Reserve reduced benchmark interest rates to near zero.
Looking forward, mREITs are likely to benefit from dramatically lower borrowing cost and stability in MBS prices.
Generally, mREITs use short-term repurchase agreements or repos to increase leverage. Borrowing costs on repos are closely related to the Fed’s target rate, which is hovering close to zero. Hence, interest expense is expected to decline meaningfully.
Moreover, as mortgage rates recorded new lows several times since March, the housing sector is expected to get a boost from improvement in origination volumes as well as refinancing activities. This is favorable for mREITs with origination business.
In fact, mortgage giant — Freddie Mac — reported that the rate for a 30-year fixed-rate home loan dropped to an average 3.03% for the week ending Jul 9. Moreover, going by numbers reported by the Mortgage Bankers Association, on Jul 15, mortgage applications increased 5.1% in the week ended Jul 10, 2020.
Amid these, improving asset pricing, MBS spreads tightening and improved hedged performance will likely enable mREITs to recover book value losses witnessed during the first quarter and support earnings in the near term.
In fact, probable book value gains during second quarter have likely allowed companies like New Residential Investment Corp. NRZ and New York Mortgage Trust NYMT that had previously reduced or suspended dividends in liquidity enhancement measures to resume dividend payments. Such moves boost investors’ confidence in the stock.
It's worth noting that mREITs don’t have monolithic risk exposure. The success or failure of a specific company is determined by the performance of the underlying investments, management's ability to execute beneficial hedges in a timely manner and use of appropriate amount of leverage.
Now, that the worst is over, the industry is filled with opportunities and an allocation to still distressed-valued mREITs industry is warranted.
Moreover, valuation of the industry remains subpar relative to the Index. We have employed trailing 12-month Price-to-Book value multiple, a commonly used metric, for determining the value of the industry. The mREIT industry is currently trading at 0.95X compared with the S&P 500’s 4.38X.
This undervaluation of the industry provides a buy opportunity, especially in agency-focused mREITs and companies with strong origination businesses.
We have used the Zacks Screener to handpick three stocks in the mREIT sector that carry a Zacks Rank #1 (Strong Buy) or a Zacks Rank #2 (Buy) and are witnessing positive estimate revisions, reflecting analyst optimism.
Apollo Commercial Real Estate Finance, Inc. ARI: This REIT primarily acquires, originates, invests in and manages performing commercial first mortgage loans, subordinate financings and other commercial real estate-related debt investments. The company sports a Zacks Rank of 1, presently. The Zacks Consensus Estimate for 2020 earnings per share has been revised 4.1% upward over the past month to $1.28.
Ares Commercial Real Estate Corporation ACRE:This specialty finance company has a national direct origination platform through which it originates and invests in commercial real estate loans and related investments. The company mainly originates senior mortgage loans, subordinate financings, mezzanine debt and preferred equity. The company currently sports a Zacks Rank of 1. The Zacks Consensus Estimate for 2020 earnings per share has been revised 14.7% upward over the past month to $1.09.
Starwood Property Trust, Inc. STWD: This Zacks Rank #2 mREIT mainly focuses on origination, acquisition, financing and management of commercial mortgage loans and other commercial real estate debt investments, commercial MBS, and other commercial real estate investments in the United States and Europe. The Zacks Consensus Estimate for 2020 earnings per share has been revised 1.1% upward over the past 30 days to $1.84.
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New York Mortgage Trust, Inc. (NYMT): Free Stock Analysis Report
STARWOOD PROPERTY TRUST, INC. (STWD): Free Stock Analysis Report
Ares Commercial Real Estate Corporation (ACRE): Free Stock Analysis Report
New Residential Investment Corp. (NRZ): Free Stock Analysis Report
Apollo Commercial Real Estate Finance (ARI): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.