3 mREIT Stocks to Buy Despite Unsettling Mortgage Market
The Zacks REIT and Equity Trust industry has been bearing the brunt of uncertainties in the macro-economic conditions due to high rates, credit spread volatility, spread widening, yield curve inversion, low market liquidity and limited fixed-income demand. This resulted in increased mortgage rates, significantly reducing originations. The mREIT industry should see book value erosion in the near term, as wider spreads in the Agency market affect asset prices.
Nonetheless, the Fed’s decision to conclude its rate-hiking cycle in 2024 indicates easing earnings pressure for highly leveraged mREITs that have been facing rising funding costs. Moreover, the Agency markets stand to recover from the interest rate relief. Hence, companies like Ladder Capital LADR, MFA Financial MFA and ACRES Commercial Realty ACR are well-poised to navigate the market blues.
About the Industry
The Zacks REIT and Equity Trust industry comprises mortgage REITs, also known as mREITs. Industry participants invest in and originate mortgages and mortgage-backed securities (MBS), and provide mortgage credit for homeowners and businesses. Typically, these companies focus on either residential or commercial mortgage markets. Some invest in both markets through the asset-backed securities. Agency securities are backed by the federal government, making it a safer bet and limiting credit risks. Also, such REITs raise funds in the debt and equity markets through common and preferred equity, repurchase agreements, structured financing, convertible and long-term debt, and other credit facilities. The net interest margin (NIM), the spread between interest income on mortgage assets and securities held, as well as funding costs, is a key revenue metric for mREITs.
What's Shaping the Future of the mREIT Industry?
Conservative Approach to Impede Returns: The unfavorable scenario in rates and the MBS markets, restricted financial conditions, and resultant negative fixed-income fund flows have put a strain on credit-risky assets. Hence, companies are making efforts to de-lever and de-risk their portfolios. This is likely to result in lower portfolio growth. Also, numerous companies have resorted to a higher hedge ratio to reduce interest rate risks and extension risks. While such moves may seem prudent amid the ongoing uncertainties, those will impede mREITs’ earnings power in the future. As companies prioritize risk and liquidity management over incremental returns, at least in the short term, we expect robust returns to remain elusive.
Industry Resorts to Dividend Cuts as Book Values Erode: Volatility in the fixed-income markets, high interest rates, and the widening of the spread between the 30-year Agency MBS and 10-year treasury rate are affecting valuations of Agency mortgage-backed securities. Hence, mREITs will continue to see book value pressure in the upcoming period. Also, liability-sensitive mREITs will see funding costs repricing faster than asset yields. Hence, we anticipate the cost of funds to be a headwind, and reduce net interest spreads and profitability. This scenario has compelled companies to reduce the dividend to a level wherein it can be covered by earnings. This may discourage mREIT investors and result in capital outflows from the industry, potentially resulting in greater book value declines for companies in the upcoming period.
Purchase Volume Deterioration to Continue: The volatility in mortgage rates has served as a hurdle for any potential recovery in purchase originations, with buyers and sellers remaining on the sidelines. Housing inventory has fallen and affordability challenges have increased due to high mortgage rates, affecting seasonal buying trends.
Amid this lackluster housing market, mortgage originations are likely to continue to be suppressed. This has caused operational and financial challenges for originators. It may also reduce the gain on sale margin and new investment activity.
Zacks Industry Rank Indicates Dismal Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #199, which places it in the bottom 21% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates an underperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is an outcome of the disappointing earnings outlook for the constituent companies. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group's earnings growth potential. The industry’s current-year earnings estimates have moved 10.8% down since December 2022.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Lags Sector and S&P 500
The Zacks REIT and Equity Trust industry has lagged the broader Zacks Finance sector and the S&P 500 composite in the past year.
The industry has slumped 2.2% in the above-mentioned period against the broader sector’s rise of 14.1%. Notably, the S&P Index has grown 22.8% over the past year.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation
Based on the trailing 12-month price-to-book (P/BV), which is a commonly used multiple for valuing mREITs, the industry is currently trading at 0.97X compared with the S&P 500’s 6.05X. Over the past five years, the industry has traded as high as 1.12X, as low as 0.39X and at the median of 0.94X.
Price-to-Book TTM
Image Source: Zacks Investment Research
3 mREIT Stocks Worth Betting On
ACRES Commercial Realty: The company is primarily focused on originating, holding and managing commercial real estate ("CRE") mortgage loans and equity investments in commercial real estate properties through direct ownership and joint ventures.
As of Sep 30, 76% of the company’s loan portfolio comprised multi-family-focused CRE. Moreover, it had $104 million in liquidity.
Earlier this month, the company’s board of directors authorized an additional $10 million of the outstanding shares of its common and preferred stock under its existing share repurchase program. In November 2021, ACRES was authorized to repurchase $20 million worth of outstanding shares of its common stock. In the nine months ended Sep 30, 2023, ACR repurchased 298,000 shares for $2.7 million. It has $4.1 million of authorization remaining under this program.
The Zacks Consensus Estimate for ACR’s 2023 earnings has been revised 12% upward over the past month to $2.43. Also, the company has an impressive earnings surprise history, having surpassed the Zacks Consensus Estimate in three of the four trailing quarters. ACR has a market cap of $80.55 million.
The company sports a Zacks Rank of 1 (Strong Buy) at present. You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: ACR
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Ladder Capital: This mREIT is a pre-eminent commercial real estate capital provider specializing in underwriting commercial real estate and offering flexible capital solutions within a sophisticated platform. It originates and invests in a diverse portfolio of commercial real estate and real estate-related assets, with a focus on senior secured assets.
The company’s balance sheet is well-positioned to benefit from a high rate environment. Its lending book consists of significant floating-rate first mortgage loans. With this, its earnings seem positively correlated to high interest rates. We see Ladder Capital’s conservative capital structure and modest leverage as a favorable fit amid the ongoing market disruption. Also, its negligible losses on originated investments since 2008 underline an impressive credit record.
In contrast to certain mREITs resorting to dividend cuts to navigate the choppy waters, LADR’s dividends seem well-covered, with 1.4X coverage based on Distributable EPS.
The company currently carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for Ladder Capital’s 2023 earnings has been unrevised in the past month. Moreover, earnings are projected to grow 12% in 2023. LADR has a market cap of $1.48 billion.
Price and Consensus: LADR
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MFA Financial: This leading specialty finance company invests in residential mortgage loans, residential MBS and other real estate assets. Through Lima One Capital, its wholly-owned subsidiary, MFA also originates and services business purpose loans for real estate investors.
In third-quarter 2023, Lima One originated a record $671 million worth of loans. Also, its investment portfolio stood at $9.26 billion as of the third-quarter end. In a bid to navigate the challenging macro-economic scenario, the company proactively hedged its duration risk by increasing the interest rate swap position. It also reduced exposure to repurchase agreements, warehouse lines and other forms of short-term funding by issuing fixed-rate securitizations.
The Zacks Consensus Estimate for the company’s 2023 earnings has been revised marginally upward over the past month. While 2023 earnings are projected to decline 19% in 2023, the same will rebound and increase 5.7% in 2024. MFA carries a Zacks Rank of #2 at present. MFA has a market cap of $1.19 billion.
Price and Consensus: MFA
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