What happened

Stocks are getting crushed on Thursday, on a muted economic outlook by the Federal Reserve and worries that the market has moved up too quickly, considering the threat the COVID-19 pandemic still presents. Real estate companies that focus on debt secured by real estate, so-called mortgage REITS, or mREITs, are taking a beating today. 

Man looking at graphic with sell and buy printed on it.

Image source: Getty Images.

The following four mREITs are notable among the hardest hit:

Mortgage REIT Price Decline on Thursday*
Annaly Capital Management (NYSE:NLY) 4.3%
Colony Capital (NYSE: CLNY) 13.5%
MFA Financial (NYSE:MFA) 15.9%
Invesco Mortgage Capital (NYSE:IVR) 19.3%

*As of 12:26 p.m. EDT. Source: YCharts.

So what

As of this writing, the market is in a full-on rout. The SPDR S&P 500 ETF Trust (NYSEMKT:SPY) is down 4.2%, one of the worst days for stocks in years (even in a year that's seen some of the biggest single-day drops in decades). This sell-off follows a massive run-up for many mREITs, or hybrid REITs like Colony Capital, which owns mortgage debt as well as physical property. Since mid May, these stocks have, as a group, run hard and fast as investors looked for the next market sector to bounce back from the coronavirus woes:

CLNY Chart

CLNY data by YCharts.

In recent days, however, investors may have started to realize they've gotten ahead of the actual recovery. Since Monday this week, many mREIT stocks have fallen hard as investors reversed course:

CLNY Chart

CLNY data by YCharts.

The whipsaw action is a product of the way that mREITs make a living: borrowing money to buy debt backed by real estate assets, and making a profit on the spread between their borrowing costs and the interest paid on the loans they own. With more than 20 million Americans unemployed, the pool of potential nonpayers has grown substantially. 

Now what

Year to date, mortgage REIT stocks are still down sharply:

CLNY Chart

CLNY data by YCharts.

And to a large extent, it makes sense that so many are down this far. This isn't the safe end of the real estate investing pool; mREITs use a substantial amount of leverage, and this creates a lot of risk during recessions. As their borrowers are late or miss payments or go into default on their loans, mREITs' cash flows get squeezed, but they still have to make the payments on the debt they take on. 

Simply put, a protracted recession could push several mREITs into insolvency. The Fed warned that it foresees a slow economic recovery, and that it could take many years to recover all of the jobs that have been (and still will be) lost. The recent sell-off in the mREIT category probably isn't a great buying opportunity, especially if you're looking for the safety of real estate; the future is uncertain for the economy, and this class of companies in particular faces an enormously difficult path. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.