3 Stocks From mREIT Industry to Buy Despite Ongoing Headwinds
The Zacks REIT and Equity Trust industry has been bearing the brunt of interest rate volatility and uncertainty in the macro-economic conditions due to high rates, low market liquidity and limited fixed-income demand. This has resulted in a rise in 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.
While rising rates have hindered origination volumes, the same continues to be tailwinds to servicing businesses, as the two segments are operational hedges for each other. Low prepayment spreads offer respite by supporting asset yields and margins, whereas business diversification will help keep companies afloat. Companies with primarily floating-rate loan books should see a rise in net interest income (NII). Hence, industry players like Starwood Property Trust, Inc. STWD, Ladder Capital Corp LADR and Invesco Mortgage Capital Inc. IVR 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 respective 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?
Purchase Volume Deterioration to Continue: The incremental volatility in mortgage rates has served as another 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.
Conservative Approach to Impede Returns: The Federal Reserve’s rate hikes to slow persistent inflation have made financial markets extremely volatile, restricting financial conditions and resulting in negative fixed-income fund flows. Given these macro worries, as strain grows on credit-risky assets, we expect mREITs to be selective in their investments, resulting in lower portfolio growth. Also, numerous companies have resorted to a higher hedge ratio to reduce interest rate risks. While such moves may seem prudent in the ongoing uncertain times, those will impede mREITs’ growth expectations. 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: High volatility in the fixed-income markets, rising 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 cut dividend coverage for many companies. 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.
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 #201, which places it in the bottom 20% 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 8.5% down since September 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 17.4% in the above-mentioned period against the broader sector’s rise of 6%. Notably, the S&P Index has gained 14.5% 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 0.86X compared with the S&P 500’s 5.84X. It is also below the sector’s trailing-12-month P/BV of 3.19X. Over the past five years, the industry has traded as high as 1.11X, as low as 0.38X and at the median of 0.93X.
Price-to-Book TTM
Image Source: Zacks Investment Research
3 mREIT Stocks Worth Betting On
Invesco Mortgage: The company primarily focuses on investing in, financing, and managing MBSs and other mortgage-related assets. Amid headwinds for Agency MBSs, the company has been actively managing its portfolio. It has reduced exposure to such securities, as the current macro situation continues to weigh on Agency RMBS valuations. IVR is shifting its Agency RMBS portfolio to higher-coupon investments by selling lower-coupon ones.
As of Jun 30, substantially all of the company’s $5.5-billion investment portfolio consisted of Agency RMBS. It had unrestricted cash and unencumbered investments aggregating $492 million.
The Zacks Consensus Estimate for IVR’s 2023 earnings has been unrevised over the past month to $5.48. Also, the company has an impressive earnings surprise history, having surpassed the Zacks Consensus Estimate in all four trailing quarters. IVR has a market cap of $485 million.
The company carries a Zacks Rank of 2 (Buy) at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: IVR
Image Source: Zacks Investment Research
Ladder Capital: This mREIT is a preeminent 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 rising 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 1.43X coverage based on Distributable EPS.
The company currently carries a Zacks Rank #2. The Zacks Consensus Estimate for Ladder Capital’s 2023 earnings has been revised marginally upward in the past two months. Moreover, earnings are projected to grow 14.7% in 2023. LADR has a market cap of $1.39 billion.
Price and Consensus: LADR
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Starwood Property: Greenwich, CT-based STWD operates through four segments — Commercial and Residential Lending, Infrastructure Lending, Property, and Investing and Servicing.
Starwood Property had a $17.7-billion diverse loan portfolio as of Jun 30, 2023, with 10% of loans backed by U.S. office properties, 20% multi-family and 10% hotel.
STWD leverages its global multi-cylinder platform to make investments. Also, as of the second-quarter 2023 end, the company had primarily floating-rate assets, positioning it well to navigate the current environment.
The Zacks Consensus Estimate for the company’s 2023 earnings has been unrevised at $1.96 over the past month. Moreover, 2023 NII is pegged at $2.06 billion, indicating a year-over-year uptick of 40.6%. Starwood Property carries a Zacks Rank of #2 at present. STWD has a market cap of $6.46 billion.
Price and Consensus: STWD
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