REIT Rankings: Mortgage REITs
This is an abridged version of the full report and rankings published on Hoya Capital Income Builder Marketplace on March 15th.
Best known for their hearty dividend yields that often breach double digits, Mortgage REITs – also called “mREITs” – comprise roughly 5% of the total REIT universe. Often viewed as a distinct asset class from equity REITs which own, operate, and collect rent on real estate properties, mortgage REITs function more like a lending bank by originating and investing in interest-bearing real estate debt instruments. mREITs have been slammed particularly by the fallout of the ongoing regional banking crisis amid a resurgence of interest rate volatility and credit concerns – erasing their once-robust gains for 2023. Everything in Moderation: While most mREITs stand on relatively decent footing with enough earnings power to maintain their hearty dividend yields, sharp changes in rates in either direction – along with sector-specific credit risk – can spell trouble for mREITs that are over-levered or improperly hedged.
Despite their volatility over the past several years, mortgage REITs don’t necessarily deserve their “ugly duckling” status within the REIT sector and we reiterate our view that maintaining a modest mREIT allocation to a balanced income-focused real estate portfolio can be a prudent strategy to hedge interest rate and inflation risk while adding immediate income. As illustrated through our Inflation Hedge Factor model, mortgage REITs provide some of the better inflation-hedging characteristics within the REIT sector and exhibit more muted interest rate sensitivity compared to their equity REIT peers.
That said, it’s important to keep in mind that mortgage REITs are not monolithic in their risk exposures. Mortgage REITs typically operate with a high degree of leverage to amplify investment spreads and often use short-term hedging instruments to manage interest rate and credit exposure, which makes each REIT rather unique in its end-exposure to certain macroeconomic environments. In general, similar to high-yield corporate credit, mortgage REITs tend to perform their best in “boring markets” – periods of lower interest rate and stock market volatility. Below, we define the five primary risk exposures faced by these different types of mortgage REITs: leverage risk, credit risk, interest rate risk, prepayment risk, and derivative risk.
Residential Mortgage REIT Overview
In the Hoya Capital Residential Mortgage REIT Index, we track the 21 exchange-listed residential mREITs, a sector that is comprised primarily of small and micro-cap REITs which pay dividend yields in the mid-to-high teens. Not unlike a traditional mortgage bank, Residential mREITs purchase or originate residential mortgages and mortgage-backed securities (“MBS”) and use leverage to enhance the investment spread between the effective lending rate and their cost of capital. As we’ll discuss throughout this report, residential mREIT Book Values remain in decent shape amid the turmoil from the recent regional banking crisis as MBS spread-widening has been more-than-offset by a decline in benchmark rates, but sharp changes in interest rates heighten the hedge-related risk for some over-levered REITs.
The sector can be further split into three sub-sectors: Agency mREITs – led by Annaly Capital (NLY) and AGNC Investment (AGNC) – invest primarily in agency mortgage-backed securities, or RMBS, which have their principal guaranteed by a Government-Sponsored Enterprise, or GSE, such as Fannie Mae, Freddie Mac, or Ginnie Mae, and thus bear minimal credit risk but tend to be more sensitive to changes in interest rates. Credit-Focused mREITs – led by Chimera (CIM), MFA Financial (MFA), and New York Mortgage (NYMT) – invest in RMBS and other types of residential credit that are not guaranteed by a GSE, including whole mortgage loans, which bear higher levels of credit risk but tend to be less sensitive to interest rates. Servicing/Origination mREITs – led by Rithm Capital (RITM) and PennyMac (PMT) – typically focus on non-traditional mortgage-related assets, including mortgage servicing rights (MSRs) and/or loan origination services.
Commercial Mortgage REIT Overview
In the Hoya Capital Commercial Mortgage REIT Index, we track 21 exchange-listed commercial mREITs. Similar to equity REITs, commercial mREITs tend to…