What is a mortgage REIT?
Residential and commercial real estate is financed through mortgage real estate investment trusts (mREITs). mREITs can originate and service loans, engage in capital market operations including securitizations, restructure or recapitalize failed credits, and provide long-term finance for homeowners and commercial property owners.
On stock exchanges like the NYSE or Nasdaq, the majority of public mREITs are listed.
Investors can have access to the $15.6 trillion market for residential and commercial mortgage investments by acquiring common shares of mREITs, which are exchange-traded, liquid companies.
mREITs have a high dividend yield that is generally 500 to 800 basis points higher than that of equity REITs.
While numerous mREITs had financial difficulties during the Global Financial Crisis (GFC) of 2007–2008 due to excessive leverage and credit concerns, other mREITs survived the crisis and even accelerated their expansion by making profitable investments in the subsequent years.
Size and Composition of the mREIT Sector
The FTSE Nareit Mortgage REITs Index included 40 mREITs as of December 31, 2019, comprising 24 that finance residential real estate and 16 that finance commercial real estate.
Residential mREITs had an equity market capitalization of $55.2 billion, while commercial mREITs had a market capitalization of $27.8 billion, for a combined market cap of $82.9 billion for the whole mREIT industry.
Investing in mREITs
Like any other publicly traded company, shares in mREITs, which are listed on key stock exchanges, may be purchased by an individual. Additionally, shares can be bought through a mutual fund or exchange-traded fund (ETF).
Because of their history of paying out relatively substantial dividends, investors have historically seen value in mREITs. Due to their high dividend yield, mREITs are especially appealing to retirees and other investors who want current income from their portfolio.
Funding Sources for mREITs
Like the majority of mortgage and MBS investors, mREITs finance their portfolios with both stock and debt. Leverage or higher debt levels boost a given equity investment’s ability to purchase a larger portfolio.
Leverage may increase profits for stock investors, but it can also increase risks since it can make losses during a downturn more severe.
Common equity, preferred shares, long-term debt, repurchase agreements, and bank loans are some examples of capital sources.
mREIT RISKS
mREITs are subject to risk just like any other financial enterprise. The majority use strategies to lessen these risks. However, no risk management method can completely remove risk; in fact, some mREITs faced considerable pressure during the GFC, and several of them failed.
But since the crisis, the majority of mREITs have opted for more conservative business strategies that are less susceptible to the kinds of risk that contributed to the GFC’s problems.
The main types of risks faced by mREITs include:
Interest rate risk
The net interest margin, which is the core source of earnings for any mREIT and is calculated as the difference between the average investment yield and the average cost of capital can be impacted by changes in interest rates.
The value of an mREIT’s mortgage assets may also be impacted by changes in interest rates, which has an impact on corporate net worth. When the underlying interest rate rises, the value or price of the Treasury bill, note, or bond declines, similar to how US Treasuries are valued.
Credit risk
Through their private-label residential MBS and CMBS, commercial mREITs may be subject to credit risk. The level of credit risk associated with a certain security is determined by the creditworthiness of the underlying loans, the security’s structure and the level of over-collateralization.
Prepayment risk
The chance that certain borrowers may refinance or repay their mortgages is impacted by changes in interest rates or house sales by borrowers. The investor owning the mortgage or MBS must reinvest the proceeds of such a refinancing or repayment into the current interest rate environment, which might be lower or higher.
Additionally, the investment premiums of MBS that prepay at par are lost by investors.
The tools and methods that mREITs employ to protect themselves against interest rate risks are also used to try to mitigate prepayment risk.
Funding or liquidity risk
mREIT assets mostly consist of longer-term MBS and mortgages, while their liabilities may contain a sizable amount of short-term debt, especially among residential mREITs.
Due to the term mismatch, they must refinance their short-term debt before their assets mature. Their capacity to do so depends on the liquidity and efficient operation of the repo market and other short-term debt markets.