Please ensure Javascript is enabled for purposes of website accessibility

Looking Ahead: How Increasing Real Estate Prices Can Elevate Mortgage REIT Performance

By Brent Nyitray, CFA - Updated Mar 30, 2021 at 11:39AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Don't forget asset prices when looking at these income vehicles.

Housing prices are rising so rapidly in the U.S. that some people are talking about another housing bubble. While there is very little possibility of that happening right now (the necessary pieces of the puzzle simply aren't there), we are seeing home price appreciation and bidding wars similar to the housing bubble days of 2004-2006.

While mortgage real estate investment trusts (REITs) are mainly sensitive to movements in interest rates, increasing house prices are another benefit. How does this help companies like Annaly Capital Management (NLY -3.59%), New Residential (NRZ 2.28%), or MFA Financial (MFA 1.63%)?

Abstract picture of financial data, with a man holding a tablet

Image source: Getty Images.

Home prices are rising at a double-digit clip

According to the National Association of Realtors, there were just over 1 million homes for sale in the United States at the end of February, which is a record low. As a result, the median home price rose 15.8% year over year. The S&P CoreLogic Case-Shiller Home Price Index reported a 10.4% gain in 2020. There is a massive supply and-demand imbalance in the single-family home market as professional investors compete with homebuyers fleeing the cities. 

While people will start throwing around terms like "bubble" every time an asset price has a large gain, it pays to understand that such things are quite rare. Residential real estate bubbles occur every third or fourth generation (the previous one was in the 1920s), and they require all significant players -- investors, bankers, and government -- to believe an asset is "special" and cannot fall. The memories of 2008 are too recent for that to really happen. Real estate prices are rising because demand is greater than supply. 

Mortgage REITs have a unique way to capitalize

Mortgage REITs are different than the traditional REIT, so it makes sense to take a minute to understand the differences. Most traditional REITs follow a tenant/landlord model, where a company builds an office building, apartment building, or shopping mall and rents out the units to individual tenants. Mortgage REITs don't invest in real property; they invest in real estate debt (i.e. mortgages). While traditional REITs earn rental income, mortgage REITs earn interest. 

So mortgage REITs that have exposure to non-government-guaranteed mortgages will benefit from rising home prices. Let's take a closer look at the three I named above.

MFA Financial's portfolio is invested primarily in residential whole loans and real estate owned (REO). The company owns about $250 million worth of properties, as a result of foreclosures. Single-family rental vehicles are hot right now, and homebuilder Lennar recently raised capital to buy existing homes, which puts it in direct competition with American Homes 4 Rent and Invitation Homes. These companies get rental income along with asset price appreciation. 

While Annaly Capital invests mainly in mortgage-backed securities that are guaranteed by the U.S. government, it also has a sizable portfolio of loans that are not guaranteed. As real estate prices rise, loan performance improves because borrowers are less likely to walk away from a property that's worth more than the mortgage owed. Second, these loans are carried on Annaly's balance sheet at 75% of face value, which means that increased refinancing activity will realize that discount quickly. 

Another mortgage REIT that will benefit is New Residential, which has a large mortgage origination arm. New Residential is big in the non-qualified mortgage space, which contains mortgages that are not guaranteed by the U.S. government. These loans carry higher rates than traditional government mortgages and are often made to professional real estate investors. This is another case where improving real estate prices will encourage stronger credit performance. New Residential will also benefit from a recent change in the rules for Fannie Mae and Freddie Mac, which will present a wider lending opportunity for the company. 

While mortgage REIT earnings are largely driven by changes in interest rates, these assets are at least somewhat sensitive to the underlying fundamentals in the real estate market. That said, these companies primarily trade on their dividend yields and book values. In an environment where we are seeing rapidly rising real estate prices, the REITs with the highest exposure to residential credit risk will benefit the most. This means that New Residential and MFA should fall in that category. That said, any mortgage REIT with exposure to real properties will reap benefits. 

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Annaly Capital Management, Inc. Stock Quote
Annaly Capital Management, Inc.
NLY
$6.45 (-3.59%) $0.24
MFA Financial, Inc. Stock Quote
MFA Financial, Inc.
MFA
$13.72 (1.63%) $0.22
New Residential Investment Corp. Stock Quote
New Residential Investment Corp.
NRZ
$11.21 (2.28%) $0.25
10X Capital Venture Acquisition Corp Stock Quote
10X Capital Venture Acquisition Corp
VCVC

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
338%
 
S&P 500 Returns
119%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/17/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.