While publicly traded real estate investment trusts as a whole have performed well in recent years and often offer substantial dividends, mortgage REITs have been lagging behind in the past year, and New York-based mortgage REITs are no exception as cyclical market movement pushes down returns.
According to the National Association of Real Estate Investment Trusts, in the past 12 months, the group’s composite REIT index had returns of 16 percent while their mortgage REIT index had returns of -8 percent.
Publicly traded REITs are slices of pooled capital that invest in real estate, but they behave like stocks, and are a much more liquid investment than actually owning property. They can specialize in specific types of properties, or in a broad range of residential and commercial properties, and are favored by investors who want dividends, which REITs must issue at regular intervals.
Mortgage REIT analyst Merrill Ross of Friedman Billings Ramsey said that mortgage REITs, which invest in mortgage loans and pools of mortgage-based capital called collateralized debt obligations, or CDOs, have been “left behind” in large part because of rising interest rates and a slowing mortgage business.
“It wasn’t too long ago that mortgage REITs were the darlings of the industry,” said Art Gering, a senior market analyst with Marcus & Millichap Research Services. “Things turned in 2005 as mortgage REITs slumped,” he said, posting a negative total return of 23.2 percent for the year.
An analysis by The Real Deal of nine New York-based mortgage REITs revealed that each under performed in the past 12 months ending mid-June when compared to the Dow Jones REIT Index.
The worst performer, down over 56 percent in the past 12 months, is New York Mortgage Trust, which trades on the New York Stock Exchange under the symbol NTR, led by chairman and president Steven Schnall.
In explaining the company’s $1.8 million loss during its first quarter conference call, Schnall said that “the current environment has presented us with some significant challenges,” but maintained that “the worst is behind us.” The multimillion-dollar first quarter loss is significant for a company with a $75 million market capitalization. By contrast, the company lost $38,000 in the first quarter of 2005 and posted a gain of $117,504 in the first quarter of 2004.
Schnall attributed New York Mortgage’s poor performance to a flattening of the yield curve and a competitive market, but stressed management’s plans to combat these “near-term” market conditions.
Still, even industry boosters are not necessarily optimistic about the mortgage business’ prospects this year as the residential market cools. The Mortgage Bankers Association of America predicts that mortgage originations will drop 14 percent this year.
Success in the mortgage industry also relies on profiting from discrepancies in long and short-term interest rates, so as the spread narrows there is less room to profit. When the Federal Reserve raises short-term interest rates and long-term interest rates either stay constant or fall, as has occurred recently, the yield curve flattens — another way of saying that the spread between long term and short term interest rates narrows — and there is less room for mortgage companies to make money.
Annaly Mortgage is another New York-based mortgage REIT that has not fared well of late, with its stock price down around 40 percent over the last year. The company recently announced a dividend of just 11 cents, down from 50 cents a couple of years ago, after two straight quarters of posting losses.
In a company press release explaining its first quarter numbers, chairman and CEO Michael Farrell explained that, despite a first quarter loss, the company is now “better-positioned to perform should the Federal Reserve continue its current course of tightening monetary policy.” He said the company has undertaken selling lower-yield assets it mostly acquired in the lower interest rate environment of 2003 and 2004 and replacing them with assets reflecting today’s higher yields.
New York-based hybrid REIT iStar Financial, which invests both in mortgage and equity (equity REITs own buildings), had a brighter first quarter, but it too under performed the REIT index, down more than 12 percent in the past year.
In its first quarter conference call, CEO Jay Sugarman stressed the company’s recent credit upgrades, and the company’s CFO, Katy Rice, touted the company’s ability to operate in a difficult market.
“Despite a very competitive environment, we generated $663 million in new financing commitments in 16 separate transactions this quarter, $610 million of which were funded,” Rice said.
Although the $610 million figure may sound impressive, this is down from $841 million in the first quarter of last year.
In an apparent effort to allay the gloom surrounding mortgage REITs, Sugarman said last month that rising interest rates may even help the company.
“It actually helps us compete against some folks who are probably a little less positioned to work out in a high interest rate environment,”
Sugarman said during a presentation at a NAREIT event. Sugarman billed the company as a one-stop shop that serves the higher end of the market and stresses relationships with customers who keep coming back.
While mortgage REITs may attempt to mitigate the negative effects of raising interest rates, Barry Vinicor, editor and publisher of Realty Stock Review, said their sensitivity to interest rates is enough to turn him away completely.
“We’re not big fans because of the way they finance their portfolios,” he said. “They come under pressure when interest rates rise.” Vinicor pointed out that in the long term, property-owning equity REITs are a safer bet, especially in a time of rising interest rates, because there is less correlation between their performance and rates. On top of pressure from increasing interest rates, mortgage REITs operate in a highly competitive market, making it even harder to profit.
In NAREIT’s Composite REIT Index there are 37 mortgage REITs, all of whom are competing for a piece of a shrinking pie. Mortgage originations for one- to four-family properties nationally declined from $826 billion in the third quarter of last year to $675 billion in the fourth quarter, according to the Mortgage Bankers Association. First quarter numbers for 2006 had not been released as of last month.
Of the seven other New York-based mortgage REITs studied, only one, NorthStar Realty Finance, saw its stock price increase in the past 12 months. It’s up 0.6 percent, still under performing major indexes.
Of the others, MortgageIT has dropped 37 percent over the past 12 months, Friedman Billings Ramsey (which is a mortgage REIT as well as an investment bank) is down around 26 percent, Newcastle Investment Corp. is down more than 23 percent, American Mortgage Acceptance has dropped around 9 percent and Capital Trust Inc. has declined around 5 percent.