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Mortgage REITs Have Experienced Strongest Growth Since Recession

money-fiveMortgage REITS (mREITs) have experienced strong growth in the decades since they debuted in the 1970s, but have enjoyed the greatest amount of growth in the years since the recession, according to a report from the Kroll Bond Ratings Agency (KBRA) released Wednesday.

The mortgage portfolios and sector market capitalization of the 19 mREITs that debuted between 2008 and 2013 grew by more than 250 percent and 320 percent, respectively, according to KBRA.

"This significant growth has been driven by a combination of factors including large amount of federal support for mortgage-backed securities (MBS) since the financial crisis coupled with strong investment demand for yield paying securities," KBRA said in the report. "The US Treasury and the Federal Reserve took significant actions to stabilize the MBS market and to support MBS prices by purchasing $1.4 trillion of MBS between 2011 and 2013."

According to KBRA, another factor in the substantial growth of mREITs since the recession is the fact that they provide competitive yields for institutional and retail investors; the FTSE NAREIT Mortgage REITs Index was 11.25 percent as of June 30, 2015, compared to the S&P 500 of 2 percent. The strong dividend yields are achieved when mortgage REITs use leverage in order to multiply the interest spread earned between the interest paid to borrow and the interest earned on mortgage-backed securities, according to KBRA.

Mortgage REIT portfolios have grown by more than $50 billion in equity and $7.8 billion in senior debt in both the residential and commercial financing sectors, driven by strong investor demand, according to KBRA. While the purchases and originations of residential MBS (both Agency and non-Agency MBS) has been responsible for much of that growth, there have been signs recently that commercial securities have contributed.

Residential mREITs have been forced to find alternatives in order to maintain target dividends, due to the current environment of margin compression with high-yielding bonds replaced with lower-yielding securities while the cost of funding has stayed the same, according to KBRA. The Agency believes that mREITs have two choices in the situation – increasing leverage or diversification.

Since most companies will likely face leverage limitations, which makes the second option, diversification is the "far more compelling" choice for traditional residential mREITs, according to KBRA. One company, Annaly Capital Management, diversified away from its Agency-only residential MBS business and into commercial real estate. Since focusing exclusively on residential MBS exposes portfolios to interest rate risk – the value of MBS in portfolios decreases as interest rates rise – venturing into commercial real estate should allow Annaly to offset challenges of rising interest rates. KBRA said it believes Annaly's move of diversifying into commercial MBS will serve as  a template for traditional mREITS that focus only on residential MBS.

"The mortgage REIT sector experienced significant growth since the financial crisis, mainly driven by a low interest rate environment that favored its business model," KBRA concluded in the report. "However, the current challenging environment of rising prepayments, margin compression and potential rising interest rates is forcing mREITs to evolve and expand from single-focus investment models."

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.

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