Among the interesting things that stood out when I recently wrote about the first quarter's 10 best-performing high-yielding REITs was the strong performance of so many of the cheaper REITs.
So, which are the cheapest mortgage REITs today?
Source: S&P Capital IQ.
Like the best-performing mortgage REITs so far this year, a lot of these names are commercial REITs, rather than their massively popular residential peers that have been attracting so much attention lately.
What's the difference? Both groups borrow money to invest in mortgage-backed securities. But companies like NorthStar, Crexus, and Resource Capital either own loans or own assets backed by commercial loans, whereas companies like Annaly and Anworth own assets that are backed by residential mortgages.
Commercial mortgages tend to be riskier, so they yield more; Crexus' investments, for instance, yield 12.2% -- far higher than its parent Annaly's 3.7%.
To compensate for this extra risk, commercial REITs tend to borrow less money and use longer-term funding, which is safer but more expensive. NorthStar, Crexus, Colony, and Resource carry zero to four times leverage, while Annaly and Anworth carry six to eight times. (Chimera owns a mixed bag earning 8.9% and carries two times leverage.)
An improving economy wouldn't be such great news for residential REITs. The economic downturn that's led to low short-term interest rates has been the primary driver of massive residential REIT yields. Although their incomes have been crimped by falling long-term rates, and today's profit-juicing short-term rates are bound to end at some point, we likely have another couple of years before the residential REIT gravy train ends and dividends plunge.
But for commercial REITs better economic conditions mean more demand, fewer vacancies, and fewer defaults. Resource and NorthStar both saw their troubled loans fall in just the past year. And with these valuations, an improving economy could mean we'll see commercial REITs outperform their residential peers over the longer term.
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Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. The Motley Fool has a disclosure policy.