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3 Promising mREIT Industry Stocks Braving Industry Challenges

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Players in the Zacks REIT and Equity Trust industry have been bearing the brunt of higher refinancing activities that are dampening net interest margin (NIM). Moreover, after a banner 2020, mortgage originations are likely to drop in 2021 and mREITs with origination business are anticipated to feel the pressure on sale margins.

Nonetheless, Fed’s constant support, persistently-low interest rates, and fiscal stimulus create an encouraging backdrop for players like New York Mortgage Trust (NYMT - Free Report) , Two Harbors Investment (TWO - Free Report) and Ready Capital Corporation (RC - Free Report) .

About the Industry

The Zacks REIT and Equity Trust industry comprises mortgage REITs, also known as mREITs. Players in this industry provide financing for income-producing properties by investing in or originating mortgages and mortgage-backed securities (MBS). Typically, these companies focus on residential or commercial mortgage markets although some invest in both markets through the respective asset-backed securities.

NIM — spread between interest income on mortgage assets and securities held and funding costs — is the key revenue metric for mREITs. These companies raise funds in both debt and equity markets through common and preferred equity, repurchase agreements, structured financing, convertible and long-term debt, and other credit facilities.

What’s Shaping the Future of the mREIT Industry?

Origination Wave Cresting: The low mortgage rates, rising home sales, and increasing house prices boosted mortgage originations in 2020, with total mortgage originations estimated to have hit a historical high of $4 trillion in 2020. However, after a banner year in 2020, Freddie Mac projects total originations to drop $700-$800 billion to $3.3 trillion in 2021 and decline further to $2.4 trillion in the next year. In fact, if the Fed continues to slow down its MBS purchases, the supply imbalance will force mortgage rates to climb higher as MBS prices drop to lure buyers. This is likely to affect mREITs with origination business and hinder gains on sale margins.

Refinance Burnout Unlikely:While refinance originations are expected to fall from $2.6 trillion in 2020 to nearly $1.8 trillion in 2021 and $895 billion in 2022, the volume still remains high. In fact, though mortgage rates are likely to be modestly up compared to 2020 levels, it can remain below 3% in the ongoing year. Therefore, refinance demand is anticipated to remain fairly elevated throughout most of 2021. The projected moderate pull-back in refinance incentive can be attributed to the 50-basis point (bps) adverse market fee on refinance mortgages from the GSEs, effective Dec 1, 2020. Moreover, the digital mortgage underwriting and appraisal waivers have eased refinancing process, thereby encouraging refinances.  This begets prepayments on previous higher-rate loans. Higher prepayments are resulting in Agency amortization, reduction in income, and hindering NIM and asset yields.

Continued Federal Purchases Promote Agency MBS Market Attractiveness: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. Continued Fed support has been injecting liquidity in the mortgage sector and improving Agency MBS outlook by tightening spreads. This will help to lift valuations of Agency MBS securities held by mREITs. Moreover, a low interest rate environment will continue to substantially reduce expense level for mREITS, thereby driving NIM expansion.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #161, which places it in the bottom 36% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is an outcome of the negative earnings outlook for the constituent companies. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing faith in this group’s earnings growth potential. The industry’s current-year earnings estimate has moved 22.4% south over the past year.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags Sector & the S&P 500

The Zacks REIT and Equity Trust industry has lagged the S&P 500 composite and the broader Zacks Finance sector in the past year.

The industry has declined 25.9% during this period against the broader sector’s rise of 2.3%. The S&P 500 Index has rallied 18.4% over the same time period.

One-Year Price Performance

Industry’s Current Valuation

On the basis of the trailing 12-month price-to-book (P/BV), which is a commonly used multiple for valuing mREITs, the industry is currently trading at 1.16X compared with the S&P 500’s 6.70X. It is also below the sector’s trailing-12-month P/BV of 3.04X. Over the past five years, the industry has traded as high as 1.36X, as low as 0.50X, and at the median of 1.17X.

Price-to-Book TTM

3 mREIT Stocks Poised to Survive the Industry Challenges

Two Harbors Investment: This mREIT primarily focuses on investing, financing and managing residential mortgage-backed securities (RMBS) and mortgage servicing rights. It currently carries a Zacks Rank #2 (Buy).

The company’s $14.7 billion investments in Agency RMBS will likely benefit from Fed’s robust purchase activity. Moreover, with the Fed advocating a low interest-rate environment, Two Harbors is well-positioned to further capitalize on operating in a lower cost market environment, given lower borrowing costs and favorable repo rolls, thereby driving spread growth.

The Zacks Consensus Estimate for 2021 earnings per share (EPS) has remained unchanged at 90 cents in a month’s time. Moreover, the figure suggests year-over-year growth of 15.4%. Shares of the company have gained 17.8% over the past three months.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: TWO

New York Mortgage Trust: This internally-managed mREIT acquires, invests, finances and manages primarily mortgage-related single-family and multi-family residential assets. Amid low mortgage rates and stay-at-home environment that has been strengthening the housing market, homeownership is increasing. Consequently, demand for single-family homes is likely to shoot up.

Hence, New York Mortgage Trust is likely to see robust securitization activity in its single-family credit segment, leading to higher gains from loan sales.

The Zacks Consensus Estimate for 2021 EPS has been revised 3.2% upward to 64 cents over the past month. This indicates 163.7% year-over-year growth. Further, shares of this Zacks Rank #2 stock have surged 44.7% over the past six months.

Price and Consensus: NYMT

Ready Capital Corporation: This Zacks Rank #2 stock is a multi-strategy real estate finance company that originates, acquires, finances and services small-to-medium balance commercial loans. In fact, it is the only nationwide specialty finance company focused on the small balance commercial (“SBC”) market.

After a pause during the second quarter, due to uncertainty in the capital markets and distressed underwriting conditions, commercial real estate lending activities are likely to pick up pace in the near future aided by fiscal stimulus and optimism of economic activity amid immunization process. Hence, with a keen focus on SBC markets, the company is likely to continue to pursue opportunities and will benefit from fragmentation in the SBC origination market.

Its shares have rallied 32.8% in the past six months. The Zacks Consensus Estimate for 2021 EPS has remained unchanged at $1.47 over the past month. Additionally, the consensus mark for 2021 net interest income is pegged at $88.96 million, indicating year-over-year growth of 12.2%.

Price and Consensus: RC

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