Author Topic: Mortgage REITs: Terrifying or Retire Today?  (Read 580 times)

ChpBstrd

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Mortgage REITs: Terrifying or Retire Today?
« on: February 02, 2021, 08:04:49 PM »
The following 4 sectors have not yet recovered from the Covid Correction:

Financials: -4.77%
Real Estate: -7.97%
Utilities: -11.51%
Energy: -30.19%

*numbers will change with a different YTD timeframe. Source: https://eresearch.fidelity.com/eresearch/markets_sectors/sectors/sectors_in_market.jhtml

In real estate and financials, the market seems to be expecting a wave of foreclosures, but anecdotal evidence in the real estate section of this forum contradicts that expectation, as do the FRED charts below. Are forbearances and stimulus payments really preventing people from being foreclosed upon? Or are they just delaying the inevitable?

Mortgage Delinquency, will it rise?: https://fred.stlouisfed.org/series/DRSFRMACBS
Months of Housing Supply, suggests this is not 2008: https://fred.stlouisfed.org/series/MSACSR
Vacancy Rate, from Q3 to Q4 was barely a blip, still near record lows: https://fred.stlouisfed.org/series/RHVRUSQ156N
Delinquency Rate on Consumer Loans is actually falling, suggesting a similar pattern for mortgages? https://fred.stlouisfed.org/series/DRCLACBS

My question is: Would you bet against the foreclosure pessimism by investing in mortgage REITs? If the market overestimates the level of future foreclosures, this could be an opportunity to lock in some ridiculous yield. E.g. the TTM yield on MORT is 7.95%

Last link: An interesting article about how forbearance seems to be preventing foreclosures (maybe until some of these properties can sell, or the owners get jobs): https://fortune.com/2021/01/19/forbearance-loans-lenders-great-recession-covid-economy/ This also suggests we are not in a 2008 situation.

chasesfish

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #1 on: February 02, 2021, 08:39:38 PM »
Which mortgage REITs?

We're not in a 2008 scenario because white collar employment is better and prices have gone up so much, even the foreclosed property is going to fetch a decent price.

My concern is a lot of these mortgage REITs borrow money to turn around and buy debt, the leverage is where they get killed.

Blindsquirrel

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #2 on: February 02, 2021, 08:48:49 PM »
  Mortgage REITS did stunning when interest rates were dropping. Now rates are below historical inflation. Though not at 2007, I absolutely am certain that a whole bunch of the paper they hold is garbage in the new work from home, low traffic at malls and retail environment. If you file for foreclosure the note takes a massive hit in value and I think a whole bunch of mortgage REITs are holding very large amounts of garbage paper. They have not recovered for a reason and the smart/hot money is definitely not flowing in that direction. Just my 2 cents and probably not worth that.

MustacheAndaHalf

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #3 on: February 03, 2021, 06:47:21 AM »
Agree it's not 2008 - selling fraudulent mortgages was a big industry then, and is unlike any other time period.

Yahoo Finance still hasn't updated Vanguard REIT's (VNQ) 2020 performance, but they show 1 year performance of -4.7%, which doesn't leave much room for recovery.

I'm holding more beaten up names, like Invesco Mortgage Capital Inc (IVR).  There's many negatives, like dilution of stock and loss of working capital.  The stock hasn't moved as much as other stocks, and it's popular with Robinhood investors.  I think it was mostly counted out, but they did something very impressive in January that got everyone's attention - they issued a dividend.  During Covid, you've got to be doing pretty well to do that!  So their stock surged recently.

I don't know how much the loss of working capital and leverage impacts where they can wind up.  If it didn't matter, they could triple from here (counting dilution).  I think it matters, and I'm not sure where they'll wind up.

I used portfolio visualizer to calculate correlations between treasury ETFs and Vanguard's REIT sector ETF (VNQ), and the correlation was close to zero.  If interest rates matter to REITs, I would expect a stronger correlation.

chasesfish

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #4 on: February 03, 2021, 07:18:05 AM »
Just an opinion...

The index is a terrible way to invest in REITs

There's such a wide spectrum of REITs and VNQ is market cap weighted, so you end up with a concentration in some really low yielding assets (data centers, cell towers, self storage).  REITs can't retain earnings due to their structure, so you don't get the powers of natural darwinism like the other indexes where the fittest survive

Price matters and once every few years, the skies will open and present to you the same REITs at a 20-40% discount from their current job.  It's real estate, you have to either do your own due diligence or not invest in it.   

(And I own a little VNQI - thought I would try this a year ago and still underwater)
« Last Edit: February 03, 2021, 07:33:03 AM by chasesfish »

ChpBstrd

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #5 on: February 03, 2021, 07:57:47 AM »
Just an opinion...

The index is a terrible way to invest in REITs

There's such a wide spectrum of REITs and VNQ is market cap weighted, so you end up with a concentration in some really low yielding assets (data centers, cell towers, self storage).  REITs can't retain earnings due to their structure, so you don't get the powers of natural darwinism like the other indexes where the fittest survive.

I agree. I donít own VNQ because I think offices and retail will soon join the low-yielding club as work and consumption shifts online.

For purposes of this post, I was thinking about pure play mortgage REITs like AGNC, NLY, MFA, CMO, or ARR. ETFs like MORT or REM have appeal, but thereís cross-contamination from the sectors we predict will be low yielding.

My latest question is whether mortgage REITs are more a bet on future foreclosure trends or on interest rates? If it is interest rates, I need to know if what matters is the absolute level or the term spread. Will read up, but welcome more input.

chasesfish

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #6 on: February 03, 2021, 08:03:41 AM »
I wish I could give more insight....

It's just never a sector I've been able to understand the risk/return metrics on.   It's tough to get visibility to see through two layers of leverage plus an underlying asset, only to end up still with a quasi-debt style investment with a cap on how much appreciation the asset can have.

At this point in my life, if I wanted this type of exposure I'd put $100,000 into a distressed debt fund through an established private equity manager.   The closest thing on the market for me is OCSL, but I made my gains after buying it mid-year and moved the money back into bonds.

ChpBstrd

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #7 on: February 03, 2021, 10:40:33 AM »
It looks like the picture is more complex than simply rising rates = bad for mREITs.

Their margins and thus their dividends are based on the interest rate spread. We can use the treasury yield curve as a proxy here. Just for sake of argument, let's say mREIT borrowing rates and mortgage rates are 0.5% above treasury rates. Suppose the mREITs use repurchase agreements to borrow at an average 6 months duration and buy at an average 20 years duration (made up numbers). Today that spread would be (1.69 + 0.5) - (0.08 + 0.5) = 1.61%.

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yield

If we go back in time to, say, Feb 1, 2017, that spread was 2.15%. Thus, not only did the 20y rate decrease by 1.11% in those 4 years, but the yield curve also compressed during that time as the shorter-durations met resistance near the 0% boundary and the longer durations kept falling. This half-percent change in the spread is translated to a much larger earnings impact when you factor in 6-8x leverage. One could make a case that the yield curve is not likely to compress further, and that's a bullish sign for mREITs.

Yet, as mREIT operating margins fell during the past 4 years, the stocks themselves mostly treaded water. Margin losses were mostly offset by appreciation of the mortgage portfolio as interest rates fell (partially offset by the loss of income due to prepayments).

If rates went back up to 2017 levels, we might expect depreciation of the mortgage portfolio to be offset by improved margins and a reduction in prepayments. However, mREITs would still be stuck with a portfolio of fixed rate mortgages and rising borrowing costs.

If borrowing rates rose beyond the interest rates in the mortgage portfolio, earnings would go below zero and one might think the mREITs would be pressured to liquidate their mortgages at highly discounted values rather than continue losing money. In reality, they hedge interest rate risks to the portfolio using swaps, swap options, treasury futures, and other instruments. Here's a good explanation: https://seekingalpha.com/article/4112107-mortgage-reits-how-hedge-interest-rate-risk

So maybe mREITs are a good choice right now IF one is willing to assume the following:

1) They have adequately hedged interest rate risk at a reasonable cost, and
2) The yield curve is more likely to expand than contract if rates rise, and
3) We will not be seeing a sharp rise in foreclosures.

I'm satisfied with assumptions #2 and #3, but I wonder if slim margins have persuaded some mREITs to reduce their hedges and bear more interest rate risk. If I can resolve that question, residential mREITs would seem like a good way to escape the risk of high valuations in the stock indexes.

Financial.Velociraptor

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #8 on: February 03, 2021, 11:24:46 AM »
I own a little NLY in my HSA brokerage.   I think NLY will at least market perform.   I like it because most of it's mortgages are "agency backed".  That is, they are insured against default by the US Government.  About 7% are unsecured but are high quality mortgages.  Anyone who bought when the price was 3.50 in the depths of the COVID crash is doing quite well.  I consider NLY to be a HOLD at today's price and wouldn't buy more.

I think you want to avoid Chimera (CIM) which holds no agency mortgages like the plague.  The key to the space is the government guarantee against homeowner default.  Otherwise, you have a crap ton of risk.

Imanuels

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Re: Mortgage REITs: Terrifying or Retire Today?
« Reply #9 on: February 04, 2021, 01:07:44 AM »
Thanks for pointing that out. I almost bought CIM a couple of days ago since it's still waaay below the former high in Feb 2020 and has a decent dividend yield. Will think about it more.