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Prospects for mREITs Brighten as Rate Hike Fears Recede
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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 the markets through respective asset-backed securities.
Residential mREITs mainly invest in low credit-risk agency RMBS — securities issued by government-sponsored enterprises. Nonetheless, some companies also hold non-agency or private-label RMBS, and residential mortgage loans.
Commercial mREITs, on the other hand, invest in CMBS, mezzanine loans, subordinated securities or construction loans, and might participate in loan securitizations. These securities are not backed by the government, hence,carry higher risks.
Net interest margin (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.
Let’s take a look at the industry’s three major themes:
Interest rate sensitivity: Managing the impact of changes in short- and long-term interest rates is at the core of mREIT operations. Since these companies borrow extensively at short-term rates and then purchase higher-yield long-term mortgage securities, unfavorable changes in interest rates can affect their NIMs. This factor may also hamper the value of mortgage assets, thereby, affectingcorporate net worth. In fact, during first-quarter 2019, the 10-year Treasuries fell below 3-month Treasury yields, inverting the yield curve. This is expected to have led to tighter NIMs for mREITs. Nonetheless, minutes of the Fed meeting held during Mar 19-20 suggested a flexible and possibly a more dovish approach to rates this year. We anticipate low agency prepayments and sentiments to improve across the broader mREIT sector.
Commercial v/s agency mREITs: Agency mREITs borrow debts that carry fixed short-term rates, while commercial mREITs often use loans which have floating rates over Libor. Hence, agency mREITs are more vulnerable to rollover risk in a way that if short-term interest rate is raised, it will impact the NIM of these companies. Commercial mREITs, however, match duration of assets and liabilities on their balance sheet and thus, face lesser rollover risk. Last year, encouraging transaction activity translated into higher demand for commercial real estate debt, resulting in solid portfolio growth for commercial lenders and mREITs alike. We expect this trend to continue this yearas well, with commercial mREITs likely to witness stellar loan growth.
Important source of funding for the housing sector: mREITs have historically played an important role in restructuring the housing finance market. As government sponsored entities (GSE) and the Federal Reserve are reducing their investment activities, refinancing the mortgage loans, RMBS and funding new mortgage originations for homebuyers will require extensive capital. With the ability to provide the required capital and liquidity to the market, mREITs are now poised to play a greater role in the housing finance market. In fact, players in the industry have steadily increased their investments in agency MBS.
Zacks Industry Rank Indicates Solid Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #96, which places it at the top 38% 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 solid 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 top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for the current year has moved down 2.5%.
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 & S&P 500
The Zacks REIT and Equity Trust industry has lagged the Zacks S&P 500 composite and the broader Zacks Finance sector for the past year.
The industry has gained 1.1% during this period compared with the S&P 500’s rally of 9.5% and the broader sector’s growth of 11.3%.
One Year Price Performance
Industry’s Current Valuation
On the basis of the trailing 12-month price-to-book ratio (P/BV), which is a commonly used multiple for valuing mREITs, the industry is currently trading at 1.3X compared with the S&P 500’s 4.1X. It is also below the sector’s trailing-12-month P/BV of 1.6X.
Price-to-Book TTM
Price-to-Book TTM
Over the past five years, the industry has traded as high as 1.32X, as low as 0.85X, and at the median of 1.09X.
Bottom Line
The recent Fed meeting bolstered the view that the central bank is likely to keep rates unchanged this year. Also, the Fed approaching the end of its tightening cycle and solid housing fundamentals will be reflected in stable-to-higher book values and strong mortgage credit performance.
Hence, credit-focused residential mREITs, which are less impacted by rate volatility, are expected to put up a good show. Additionally, as we progress further into the credit cycle, we applaud companies with diversified investment strategies and a seasoned portfolio that can easily adjust at times when unfavorable volatility movements weighs on certain assets/strategies.
We are presenting three stocks with a Zacks Rank #2 (Buy) that investors may consider betting on.
Annaly Capital Management, Inc. (NLY - Free Report) : This Zacks #2 Ranked company primarily owns, manages and finances a portfolio of real estate related investment securities.It has four investment groups — Agency, Residential Credit, Commercial Real Estate and Middle Market Lending. The company’s Zacks Consensus Estimate for the current-year earnings per share (EPS) was revised marginally upward, over the past week. Further, it outperformed the Zacks Consensus Estimate by average of 1.8%, in the trailing four quarters.
Price and Consensus: NLY
MFA Mortgage Investments, Inc. (MFA - Free Report) : This Zacks Rank #2 company is primarily engaged in the business of investing in mortgage-backed securities. In addition, it provides investment advisory services to a third-party institution with respect to their MBS portfolio investments. The company’s Zacks Consensus Estimate for 2019 earnings per share (EPS) has been revised marginally upward in two months’ time. Further, its 2020 earnings are expected to improve 8.7% on a year-over-year basis
Price and Consensus: MFA
KKR Real Estate Finance Trust Inc. (KREF - Free Report) : This residential real estate finance company focuses primarily on originating and acquiring senior loans secured by commercial real estate assets. The New York-headquartered company currently carries a Zacks Rank of 2. The ongoing year’sconsensus EPS estimate for the company moved marginally north to $1.75, inthe past 60 days. Moreover, it surpassed the Zacks Consensus Estimate by average of 14.4% in the last four quarters.
Price and Consensus: KREF
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Prospects for mREITs Brighten as Rate Hike Fears Recede
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 the markets through respective asset-backed securities.
Residential mREITs mainly invest in low credit-risk agency RMBS — securities issued by government-sponsored enterprises. Nonetheless, some companies also hold non-agency or private-label RMBS, and residential mortgage loans.
Commercial mREITs, on the other hand, invest in CMBS, mezzanine loans, subordinated securities or construction loans, and might participate in loan securitizations. These securities are not backed by the government, hence,carry higher risks.
Net interest margin (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.
Let’s take a look at the industry’s three major themes:
Zacks Industry Rank Indicates Solid Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #96, which places it at the top 38% 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 solid 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 top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for the current year has moved down 2.5%.
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 & S&P 500
The Zacks REIT and Equity Trust industry has lagged the Zacks S&P 500 composite and the broader Zacks Finance sector for the past year.
The industry has gained 1.1% during this period compared with the S&P 500’s rally of 9.5% and the broader sector’s growth of 11.3%.
One Year Price Performance
Industry’s Current Valuation
On the basis of the trailing 12-month price-to-book ratio (P/BV), which is a commonly used multiple for valuing mREITs, the industry is currently trading at 1.3X compared with the S&P 500’s 4.1X. It is also below the sector’s trailing-12-month P/BV of 1.6X.
Price-to-Book TTM
Price-to-Book TTM
Over the past five years, the industry has traded as high as 1.32X, as low as 0.85X, and at the median of 1.09X.
Bottom Line
The recent Fed meeting bolstered the view that the central bank is likely to keep rates unchanged this year. Also, the Fed approaching the end of its tightening cycle and solid housing fundamentals will be reflected in stable-to-higher book values and strong mortgage credit performance.
Hence, credit-focused residential mREITs, which are less impacted by rate volatility, are expected to put up a good show. Additionally, as we progress further into the credit cycle, we applaud companies with diversified investment strategies and a seasoned portfolio that can easily adjust at times when unfavorable volatility movements weighs on certain assets/strategies.
We are presenting three stocks with a Zacks Rank #2 (Buy) that investors may consider betting on.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Annaly Capital Management, Inc. (NLY - Free Report) : This Zacks #2 Ranked company primarily owns, manages and finances a portfolio of real estate related investment securities.It has four investment groups — Agency, Residential Credit, Commercial Real Estate and Middle Market Lending. The company’s Zacks Consensus Estimate for the current-year earnings per share (EPS) was revised marginally upward, over the past week. Further, it outperformed the Zacks Consensus Estimate by average of 1.8%, in the trailing four quarters.
Price and Consensus: NLY
MFA Mortgage Investments, Inc. (MFA - Free Report) : This Zacks Rank #2 company is primarily engaged in the business of investing in mortgage-backed securities. In addition, it provides investment advisory services to a third-party institution with respect to their MBS portfolio investments. The company’s Zacks Consensus Estimate for 2019 earnings per share (EPS) has been revised marginally upward in two months’ time. Further, its 2020 earnings are expected to improve 8.7% on a year-over-year basis
Price and Consensus: MFA
KKR Real Estate Finance Trust Inc. (KREF - Free Report) : This residential real estate finance company focuses primarily on originating and acquiring senior loans secured by commercial real estate assets. The New York-headquartered company currently carries a Zacks Rank of 2. The ongoing year’sconsensus EPS estimate for the company moved marginally north to $1.75, inthe past 60 days. Moreover, it surpassed the Zacks Consensus Estimate by average of 14.4% in the last four quarters.
Price and Consensus: KREF
Radical New Technology Creates $12.3 Trillion Opportunity
Imagine buying Microsoft stock in the early days of personal computers… or Motorola after it released the world’s first cell phone. These technologies changed our lives and created massive profits for investors.
Today, we’re on the brink of the next quantum leap in technology. 7 innovative companies are leading this “4th Industrial Revolution” - and early investors stand to earn the biggest profits.
See the 7 breakthrough stocks now>>