What happened
Shares of mortgage real estate investment trust (REIT) Annaly Capital Management (NLY 0.59%) rose 13% in July according to data from S&P Global Market Intelligence. Although that's nice to see, the stock was still down roughly 20% through the first seven months of the year. And, at its worst, was off around 55% during the early 2020 bear market.
So what
The key here is that mortgage REITs like Annaly are not your typical real estate investment trusts. They do not own physical assets, instead holding a portfolio of mortgages. Equally important, leverage is employed to boost investor returns. The collateral for that debt, meanwhile, is the REIT's portfolio of loans. That's a dicey situation since the value of the loans can fall swiftly during sharp market dislocations, leading to calls from lenders for additional capital. If a mortgage REIT can't come up with the cash to satisfy its lenders it will be forced to sell mortgage assets -- right when their prices are low. When the market fell earlier in the year investors were afraid that Annaly and other mortgage REITs would end up sliding into a downward spiral.
Image source: Getty Images.
That hasn't happened, though the REIT did cut its dividend by around 12% in the second quarter. That actually wasn't too bad compared to other REITs, some of which completely eliminated their dividend payouts. And, when Annaly announced second-quarter earnings at the end of July, it noted that the value of its portfolio had increased nearly 12% from its first-quarter level. That's good news, suggesting that the turmoil in the early part of the year has passed. Investors have been, perhaps understandably, upbeat based on the improving situation at Annaly.
Now what
It's hard to suggest that mortgage REITs are appropriate for most investors. They are complicated investments and leverage is a big, and risky, piece of the equation. Although Annaly has done an admirable job of navigating through a difficult period, these shares are only appropriate for sophisticated investors willing to pay very close attention to their portfolios. Given that COVID-19 has yet to be contained, extra close attention is probably what's needed right now.
