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mREITs' Outlook Bleak on Adverse Macro-Economic Conditions
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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 markets through the 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 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:
Challenging macro-economic conditions: mREITs’ operating performance depend upon conditions prevailing in the MBS and broader financial markets, as well as on the macro-economic situation. The deteriorating economic data, weak inflation expectation, heightened uncertainty about the long-term impact of tariffs and the prevalent trade tensions have amplified economic growth uncertainty, causing market volatility. Responding to these, short-term rates and mortgage rates have declined. Moreover, such an adverse financial market condition might result in de-leveraging of the global financial system, constrained debt service capabilities and forced sale of mortgage assets.
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 mar their NIMs. This will also likely hamper the value of mortgage assets, thereby, affecting their corporate net worth. The rapidly-changing interest-rate environment is the key theme which has dominated financial markets year to date. Although the current low-interest rate is driving strong originations, it has resulted in asset write-downs, in turn impacting mortgage service rights (MSR) valuations.
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 roll-over risk in a way that if the 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 roll-over 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. The trend is anticipated to continue this year as well, with commercial mREITs likely to witness stellar loan growth.
Zacks Industry Rank Indicates Weak Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #152, which places it at the bottom 41% 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 dull 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 negative earnings outlook for the constituent companies. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing faith in this group’s earnings growth potential. The industry’s current-year earnings estimate moved 8.8% south, over the past 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 & 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 dipped 13.2% during this period compared with the S&P 500’s and broader sector’s decline of 0.2% and 6.1%, respectively.
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 1.17X compared with the S&P 500’s 3.93X. It is also below the sector’s trailing-12-month P/BV of 2.63X.
Price-to-Book TTM
Price-to-Book TTM
Over the past five years, the industry has traded as high as 1.33X, as low as 0.86X, and at the median of 1.12X.
Bottom Line
Near-term growth prospects of mREITs are being questioned, as periodic bouts of volatility in the broader financial markets continue to dampen these companies’ financials. The direction of the U.S. economy is becoming less certain, marching ahead. In fact, low treasury yields and the Federal Reserve’s decision to lower short-term rates supports the view of a weakening economic outlook.
Amid these uncertainties, the 30-year fixed-rate mortgage dipped below 4% in the last week of May, and has been stable since then. Low mortgage rates have resulted in a spike in purchase and refinance mortgage applications. This introduces refinancing risk in the agency market. In fact, in second-quarter 2019, agency MBS performance was dismal, thereby impacting book value of mREITs.
The lagging effect of lower mortgage rates in the form of high prepayments and refinancing is expected to be realized in the upcoming months as well. Hence, in the upcoming period, asset selection will be crucial to strong performance of mREIT players.
Despite the turbulent environment, we have handpicked a few stocks, with a favorable Zacks Rank of 1 (Strong Buy), that investors may consider betting on, at present.
Safehold Inc. (SAFE - Free Report) : Formerly known as Safety, Income & Growth Inc., the company is engaged in acquiring, managing and capitalizing ground leases. Ground leases are long-term contracts between the company and a leaseholder or tenant. The company aims to achieve steady and growing income as well as deliver long-term capital appreciation to its shareholders. The stock’s Zacks Consensus Estimate for the current-year net income per share is pegged at $1.14, suggesting year-over-year growth of 78.1%. Further, the 2020 estimate for net income per share calls for a year-over-year improvement of 25.9%.
Price and Consensus: SAFE
Redwood Trust, Inc. (RWT - Free Report) : Redwood Trust is a specialty finance company that focuses on making credit-sensitive investments in single-family residential, multi-family mortgages and related assets. The company is also engaged in mortgage banking activities. The company surpassed the Zacks Consensus Estimate by an average of 4.8%, over the last four quarters. The Zacks Consensus Estimate for 2019 earnings per share (EPS) has been revised marginally upward in a month’s time. Moreover, a favorable estimate revision for 2020 EPS calls for year-over-year growth of 11.3%.
Price and Consensus: RWT
Exantas Capital Corp. : The company invests in commercial real estate-related assets such as whole loans, commercial mortgage-backed securities (CMBS) and CRE equity investments. It surpassed the Zacks Consensus Estimate over the trailing four quarters, the average positive surprise being 7.63%. In addition, the ongoing year’s consensus EPS estimate for the company moved 6.5% north to $1.14, in the past 60 days. This indicates a year-over-year surge of 60.6%.
Price and Consensus: XAN
Legalizing THIS Could Be Even Bigger than Marijuana
Americans spend an estimated $150 billion in this industry every year… more than twice as much as they spend on marijuana.
Now that 8 states have fully-legalized it (with several more states following close behind), Zacks has identified 5 stocks that could soar in response to the powerful demand. One industry insider described the future as “mind-blowing” – and early investors can still get in ahead of the surge.
Image: Bigstock
mREITs' Outlook Bleak on Adverse Macro-Economic Conditions
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 markets through the 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 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 Weak Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #152, which places it at the bottom 41% 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 dull 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 negative earnings outlook for the constituent companies. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing faith in this group’s earnings growth potential. The industry’s current-year earnings estimate moved 8.8% south, over the past 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 & 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 dipped 13.2% during this period compared with the S&P 500’s and broader sector’s decline of 0.2% and 6.1%, respectively.
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 1.17X compared with the S&P 500’s 3.93X. It is also below the sector’s trailing-12-month P/BV of 2.63X.
Price-to-Book TTM
Price-to-Book TTM
Over the past five years, the industry has traded as high as 1.33X, as low as 0.86X, and at the median of 1.12X.
Bottom Line
Near-term growth prospects of mREITs are being questioned, as periodic bouts of volatility in the broader financial markets continue to dampen these companies’ financials. The direction of the U.S. economy is becoming less certain, marching ahead. In fact, low treasury yields and the Federal Reserve’s decision to lower short-term rates supports the view of a weakening economic outlook.
Amid these uncertainties, the 30-year fixed-rate mortgage dipped below 4% in the last week of May, and has been stable since then. Low mortgage rates have resulted in a spike in purchase and refinance mortgage applications. This introduces refinancing risk in the agency market. In fact, in second-quarter 2019, agency MBS performance was dismal, thereby impacting book value of mREITs.
The lagging effect of lower mortgage rates in the form of high prepayments and refinancing is expected to be realized in the upcoming months as well. Hence, in the upcoming period, asset selection will be crucial to strong performance of mREIT players.
Despite the turbulent environment, we have handpicked a few stocks, with a favorable Zacks Rank of 1 (Strong Buy), that investors may consider betting on, at present.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Safehold Inc. (SAFE - Free Report) : Formerly known as Safety, Income & Growth Inc., the company is engaged in acquiring, managing and capitalizing ground leases. Ground leases are long-term contracts between the company and a leaseholder or tenant. The company aims to achieve steady and growing income as well as deliver long-term capital appreciation to its shareholders. The stock’s Zacks Consensus Estimate for the current-year net income per share is pegged at $1.14, suggesting year-over-year growth of 78.1%. Further, the 2020 estimate for net income per share calls for a year-over-year improvement of 25.9%.
Price and Consensus: SAFE
Redwood Trust, Inc. (RWT - Free Report) : Redwood Trust is a specialty finance company that focuses on making credit-sensitive investments in single-family residential, multi-family mortgages and related assets. The company is also engaged in mortgage banking activities. The company surpassed the Zacks Consensus Estimate by an average of 4.8%, over the last four quarters. The Zacks Consensus Estimate for 2019 earnings per share (EPS) has been revised marginally upward in a month’s time. Moreover, a favorable estimate revision for 2020 EPS calls for year-over-year growth of 11.3%.
Price and Consensus: RWT
Exantas Capital Corp. : The company invests in commercial real estate-related assets such as whole loans, commercial mortgage-backed securities (CMBS) and CRE equity investments. It surpassed the Zacks Consensus Estimate over the trailing four quarters, the average positive surprise being 7.63%. In addition, the ongoing year’s consensus EPS estimate for the company moved 6.5% north to $1.14, in the past 60 days. This indicates a year-over-year surge of 60.6%.
Price and Consensus: XAN
Legalizing THIS Could Be Even Bigger than Marijuana
Americans spend an estimated $150 billion in this industry every year… more than twice as much as they spend on marijuana.
Now that 8 states have fully-legalized it (with several more states following close behind), Zacks has identified 5 stocks that could soar in response to the powerful demand. One industry insider described the future as “mind-blowing” – and early investors can still get in ahead of the surge.
See these 5 “sin stocks” now >>