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3 Stalwart mREIT Stocks That Can Battle Interest Rate Headwinds
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The Zacks REIT and Equity Trust industry, which recovered well from the pandemic blues, is expected to be unfavorable in the near term, with an aggressive interest rate hike cycle in the ongoing year. This will cause damages to the business models of mortgage REITs. We expect these companies to see reductions in book values and net interest spreads. Further, amid the rising mortgage rates, the mortgage production boom continues to fade. This is likely to drive pricing competition on the origination front and result in depressed gain-on-sale margins.
Nonetheless, receding prepayment spreads offer respite to industry players by supporting asset yields and margins, whereas business diversification offers support amid volatile conditions. These create an encouraging backdrop for players like Starwood Property Trust (STWD - Free Report) , Arbor Realty Trust (ABR - 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. Industry players invest in and originate mortgages and mortgage-backed securities (MBS), thereby providing mortgage credit for homeowners and businesses. Typically, these companies focus on residential or commercial mortgage markets, although some invest in both markets through the respective asset-backed securities. Agency securities are backed by the federal government, making it a safer bet and limiting credit risk. Also, such REITs 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. Net interest margin (NIM), spread between interest income on mortgage assets and securities held and funding costs, is the key revenue metric for mREITs.
What's Shaping the Future of the mREIT Industry?
Challenging Mortgage Production Environment to Limit Revenues: Amid the tight labor markets and all-time-high inflation level, the Federal Reserve is in the midst of a shift from quantitative easing to tightening, with a reduction in asset purchases and rising short-term interest rates. These are likely to result in yield curve flattening, with a rise in short and intermediate-term rates. Russia’s invasion of Ukraine might also influence Fed’s monetary policy decisions for the ongoing year. Since the yield curve impacts the path of mortgage rates, the macroeconomic backdrop indicates that mortgage rates will witness an uptick in the upcoming period. These factors are likely to lead to lower origination volumes, especially refinancing, as incentives for borrowers to refinance loans are likely to fade. These might impede revenue growth for mortgage servicers and originators as competition increases in the origination market.
Net Interest Spread & Book Values to Decline: The Fed’s efforts to control inflation and increase interest rates are likely to be significant hindrances for mREITs. This is because mREITs finance the purchase of high-yielding mortgage assets through low-cost financing. Hence, mortgage REITs, which had been enjoying higher net interest spreads on low borrowing costs, are expected to see margin risks and profitability deterioration in the upcoming period. This may discourage mREIT investors and result in capital outflows from the industry, potentially resulting in even greater book value declines for industry players in the upcoming period.This aside, the majority of commercial mREITs tend to have floating-rate liabilities, implying an increase in interest expenses when rates go up. Mortgage spread widening and depressed gain-on-sale margins are also expected to continue in the upcoming period.
Conservative Approach to Impede Returns: Recognizing the growing concerns in the current financial markets, mREITs have resorted to adjustments in their investment portfolio. With Fed accelerating its Agency asset purchase tapering, expected spread widening and higher volatility; the companies have been trimming investment portfolios and increasing hedge ratios. Although such hedging strategies are sketched to help offset interest rate fluctuations, these are not designed to shield it against fluctuations in tangible net book value due to changes in the spread between investments and other benchmark rates like swap and treasury rates. This exposes companies to the risk of adverse spread changes. Moreover, as companies prioritize risk and liquidity management over incremental returns amid the volatility in the current market, at least in the short term, robust returns are expected to remain elusive.
Zacks Industry Rank Reflects Dismal Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #232, which places it in the bottom 6% 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 bright 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 gradually losing confidence in this group's earnings growth potential. The industry’s current-year earnings estimate has moved marginally down since May last 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 and S&P 500
The Zacks REIT and Equity Trust industry has lagged the broader Zacks Finance sector and the S&P 500 composite in the past year.
The industry has slipped 13.5% during this period against the broader sector’s growth of 2.1%. The S&P Index has risen 5% over the past year.
One-Year Price Performance
Image Source: Zacks Investment Research
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 1.13X compared with the S&P 500’s 6.19X. It is also below the sector’s trailing-12-month P/BV of 3.51X. Over the past five years, the industry has traded as high as 1.32X, as low as 1.12X, and at the median of 1.25X.
Price-to-Book TTM
Image Source: Zacks Investment Research
Three mREIT Stocks Worth Betting On
Ready Capital: The mREIT, headquartered in New York, primarily focuses on originating and servicing small-to-medium balance commercial loans. RC is likely to reap benefits from its inorganic growth moves, which have increased scale and expanded capabilities. Also, its diversified and recurring revenues from stabilized net interest and servicing revenues from gain-on-sale operations are expected to drive top-line growth.
Ready Capitalprovides life-cycle financing to small-balance commercial properties. This has likely provided it a competitive edge over peers. Strong demand in its small-balance commercial portfolio is anticipated to bolster RC’s loan growth. Bridge lending, industrial and SBA loan categories are expected to be other key strengths.
The company sports a Zacks Rank of 1 (Strong Buy) at present. The Zacks Consensus Estimate for its 2022 earnings has been revised 7.5% upward over the past week to $2.14, indicating significant year-over-year growth. Moreover, 2022 net interest income (NII) estimates of $268.2 million indicate a year-over-year uptick of 41.2%.
Arbor Realty: The New York-headquartered mREIT primarily focuses on originating and servicing loans for multi-family, single-family and other commercial real estate assets.Arbor Realty’s diversified investment focus on commercial real estate debt investments, mortgage servicing and commercial mortgage-backed securities is likely to enable it to generate stable income in the upcoming quarters despite the challenging economic environment.
Further, multifamily mortgage loan securitization and originations are expected to expand ABR’s fee-based servicing portfolio, thereby driving servicing revenues.
The company currently carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for first-quarter 2022 earnings has been revised 14.6% upward to 47 cents in a month. Moreover, 2022 NII estimates of $704.2 million indicate a year-over-year uptick of 51%.
Price and Consensus: ABR
Image Source: Zacks Investment Research
Starwood Property:Greenwich, CT-based STWD operates through four segments — Commercial and Residential Lending, Infrastructure Lending, Property and Investing, and Servicing segments.
Starwood Property had a $14.2-billion diverse loan portfolio as of Dec 31, 2021, with 29% of loans backed by office properties, 27% multifamily and 19% hotel. Also, 11% of its loans were backed by mixed-use, 6% industrial, 2% residential, 2% retail and 4% in other property types.
STWD leverages its global multi-cylinder platform to make investments. As of 2021-end, the company had $24.1 billion of primarily floating-rate assets, positioning it well to navigate the current environment.
The Zacks Consensus Estimate for the company’s first-quarter 2022 earnings has been revised 1.9% upward to 54 cents over the past month. Moreover, 2022 NII is pegged at $1.42 billion, indicating a year-over-year uptick of 21.4%. Starwood Property carries a Zacks Rank of #2 at present.
Price and Consensus: STWD
Image Source: Zacks Investment Research
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3 Stalwart mREIT Stocks That Can Battle Interest Rate Headwinds
The Zacks REIT and Equity Trust industry, which recovered well from the pandemic blues, is expected to be unfavorable in the near term, with an aggressive interest rate hike cycle in the ongoing year. This will cause damages to the business models of mortgage REITs. We expect these companies to see reductions in book values and net interest spreads. Further, amid the rising mortgage rates, the mortgage production boom continues to fade. This is likely to drive pricing competition on the origination front and result in depressed gain-on-sale margins.
Nonetheless, receding prepayment spreads offer respite to industry players by supporting asset yields and margins, whereas business diversification offers support amid volatile conditions. These create an encouraging backdrop for players like Starwood Property Trust (STWD - Free Report) , Arbor Realty Trust (ABR - 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. Industry players invest in and originate mortgages and mortgage-backed securities (MBS), thereby providing mortgage credit for homeowners and businesses. Typically, these companies focus on residential or commercial mortgage markets, although some invest in both markets through the respective asset-backed securities. Agency securities are backed by the federal government, making it a safer bet and limiting credit risk. Also, such REITs 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. Net interest margin (NIM), spread between interest income on mortgage assets and securities held and funding costs, is the key revenue metric for mREITs.
What's Shaping the Future of the mREIT Industry?
Challenging Mortgage Production Environment to Limit Revenues: Amid the tight labor markets and all-time-high inflation level, the Federal Reserve is in the midst of a shift from quantitative easing to tightening, with a reduction in asset purchases and rising short-term interest rates. These are likely to result in yield curve flattening, with a rise in short and intermediate-term rates. Russia’s invasion of Ukraine might also influence Fed’s monetary policy decisions for the ongoing year. Since the yield curve impacts the path of mortgage rates, the macroeconomic backdrop indicates that mortgage rates will witness an uptick in the upcoming period. These factors are likely to lead to lower origination volumes, especially refinancing, as incentives for borrowers to refinance loans are likely to fade. These might impede revenue growth for mortgage servicers and originators as competition increases in the origination market.
Net Interest Spread & Book Values to Decline: The Fed’s efforts to control inflation and increase interest rates are likely to be significant hindrances for mREITs. This is because mREITs finance the purchase of high-yielding mortgage assets through low-cost financing. Hence, mortgage REITs, which had been enjoying higher net interest spreads on low borrowing costs, are expected to see margin risks and profitability deterioration in the upcoming period. This may discourage mREIT investors and result in capital outflows from the industry, potentially resulting in even greater book value declines for industry players in the upcoming period.This aside, the majority of commercial mREITs tend to have floating-rate liabilities, implying an increase in interest expenses when rates go up. Mortgage spread widening and depressed gain-on-sale margins are also expected to continue in the upcoming period.
Conservative Approach to Impede Returns: Recognizing the growing concerns in the current financial markets, mREITs have resorted to adjustments in their investment portfolio. With Fed accelerating its Agency asset purchase tapering, expected spread widening and higher volatility; the companies have been trimming investment portfolios and increasing hedge ratios. Although such hedging strategies are sketched to help offset interest rate fluctuations, these are not designed to shield it against fluctuations in tangible net book value due to changes in the spread between investments and other benchmark rates like swap and treasury rates. This exposes companies to the risk of adverse spread changes. Moreover, as companies prioritize risk and liquidity management over incremental returns amid the volatility in the current market, at least in the short term, robust returns are expected to remain elusive.
Zacks Industry Rank Reflects Dismal Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #232, which places it in the bottom 6% 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 bright 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 gradually losing confidence in this group's earnings growth potential. The industry’s current-year earnings estimate has moved marginally down since May last 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 and S&P 500
The Zacks REIT and Equity Trust industry has lagged the broader Zacks Finance sector and the S&P 500 composite in the past year.
The industry has slipped 13.5% during this period against the broader sector’s growth of 2.1%. The S&P Index has risen 5% over the past year.
One-Year Price Performance
Image Source: Zacks Investment Research
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 1.13X compared with the S&P 500’s 6.19X. It is also below the sector’s trailing-12-month P/BV of 3.51X. Over the past five years, the industry has traded as high as 1.32X, as low as 1.12X, and at the median of 1.25X.
Price-to-Book TTM
Image Source: Zacks Investment Research
Three mREIT Stocks Worth Betting On
Ready Capital: The mREIT, headquartered in New York, primarily focuses on originating and servicing small-to-medium balance commercial loans. RC is likely to reap benefits from its inorganic growth moves, which have increased scale and expanded capabilities. Also, its diversified and recurring revenues from stabilized net interest and servicing revenues from gain-on-sale operations are expected to drive top-line growth.
Ready Capitalprovides life-cycle financing to small-balance commercial properties. This has likely provided it a competitive edge over peers. Strong demand in its small-balance commercial portfolio is anticipated to bolster RC’s loan growth. Bridge lending, industrial and SBA loan categories are expected to be other key strengths.
The company sports a Zacks Rank of 1 (Strong Buy) at present. The Zacks Consensus Estimate for its 2022 earnings has been revised 7.5% upward over the past week to $2.14, indicating significant year-over-year growth. Moreover, 2022 net interest income (NII) estimates of $268.2 million indicate a year-over-year uptick of 41.2%.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: RC
Image Source: Zacks Investment Research
Arbor Realty: The New York-headquartered mREIT primarily focuses on originating and servicing loans for multi-family, single-family and other commercial real estate assets.Arbor Realty’s diversified investment focus on commercial real estate debt investments, mortgage servicing and commercial mortgage-backed securities is likely to enable it to generate stable income in the upcoming quarters despite the challenging economic environment.
Further, multifamily mortgage loan securitization and originations are expected to expand ABR’s fee-based servicing portfolio, thereby driving servicing revenues.
The company currently carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for first-quarter 2022 earnings has been revised 14.6% upward to 47 cents in a month. Moreover, 2022 NII estimates of $704.2 million indicate a year-over-year uptick of 51%.
Price and Consensus: ABR
Image Source: Zacks Investment Research
Starwood Property:Greenwich, CT-based STWD operates through four segments — Commercial and Residential Lending, Infrastructure Lending, Property and Investing, and Servicing segments.
Starwood Property had a $14.2-billion diverse loan portfolio as of Dec 31, 2021, with 29% of loans backed by office properties, 27% multifamily and 19% hotel. Also, 11% of its loans were backed by mixed-use, 6% industrial, 2% residential, 2% retail and 4% in other property types.
STWD leverages its global multi-cylinder platform to make investments. As of 2021-end, the company had $24.1 billion of primarily floating-rate assets, positioning it well to navigate the current environment.
The Zacks Consensus Estimate for the company’s first-quarter 2022 earnings has been revised 1.9% upward to 54 cents over the past month. Moreover, 2022 NII is pegged at $1.42 billion, indicating a year-over-year uptick of 21.4%. Starwood Property carries a Zacks Rank of #2 at present.
Price and Consensus: STWD
Image Source: Zacks Investment Research