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  • Jonathan Poyer

Investing in Mortgage REITs and Residential Real Estate - Book Values are Growing and Credit Has Never Been Stronger

Updated: 6 days ago

In 1Q2024, we continued to be focused on finding deep value investment opportunities in the market for real estate related securities. We define this segment of the investing universe as equity and debt investments in REITs and other real estate related companies, as well as structured credit securities (backed by real estate or mortgages).

Mortgage REITs - represented by FTSE NAREIT Mortgage Plus Capped Index were relatively flat for 1Q2024. This subsector slightly outperformed the broader equity REIT index although performance was still underwhelming compared to the broader market. Much like 4Q2023, performance in the mortgage REIT market was nuanced as many of the larger mortgage REITs posted positive returns while smaller cap names generally declined in price. Also, much like 4Q2023, mortgage operating companies (originators, servicers, and insurance companies) outperformed mortgage REITs with some mortgage servicers and mortgage insurance companies posting double digit returns.

Despite relatively stagnant or lower equity prices, we believe mortgage REITs will generally report higher book values for the quarter, reflecting the tightening of mortgage credit spreads. Many non-agency residential mortgage REITs ended the quarter trading at sizeable discounts to tangible book value and attractive dividend yields. In addition to normalizing price to book ratios, we believe book values have material upside as interest rates stabilize and credit spreads tighten to reflect the lack of fundamental risk in parts of the mortgage market.

(For the above graph, VNQ represents equity REITs and REM mortgage REITs.)

Unsecured corporate bonds issued by mortgage REITs/servicers generally appreciated in price for 1Q2024. We continue to think this part of the market should attract cross-over buyers from structured credit as some names continue to trade at attractive credit spreads. One good sign for this market came when Rithm Capital (RITM) tendered one of its corporate bonds, which had been trading at a discount, at par in March. In our opinion, despite higher prices in this part of the market, there remains opportunity given the inherent dislocation and strong balance sheets of mortgage REITs and servicers.

We believe several residential mortgage REITs should be able to pay double digit dividends and are using safer forms of leverage versus the pre-pandemic period. Book values for certain mortgage REITs are, in our opinion, poised to rise as interest rates stabilize, and there is room for spread tightening (both the agency basis and credit spreads). We continued to avoid material risk in commercial real estate – namely deep mezzanine CMBS and equity REITs. Equity REITs tend to have concentrated commercial real estate exposure which we believe will be under pressure. We believe the current level of interest rates will provide challenges for most sub-sectors in the equity REIT market as dividend yields are relatively low.

Mortgage rates are likely to remain elevated in the short term but decline later in the year with longer term rates. Also, part of the decline will likely be from the tightening of the “basis” between Agency MBS and Treasury yields which remains wide relative to the historical average. Residential mortgage defaults will likely remain low given the aforementioned dynamic of borrower equity as well as a resilient economy. While we wouldn’t bet on significant home price appreciation in the short term, we believe the way to play stability in the housing market is by investing in certain RMBS, corporate credit, and mortgage related equities. Also, given the “trapped equity” that many people have in their homes, we are likely to see increasing origination in second lien mortgages, reverse mortgages, and home equity investments. Certain originators of these products who are publicly traded will likely benefit from this, as well as structured credit investors who are able to source bonds at attractive yields.

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1 Comment

May 21

Great insights here. Clearly this team continues to be ahead of the curve with their adaptive approach to RE.

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