This is a good time to be a mortgage real estate investment trust (REIT). Returns are positive, as are dividends, and industry experts say the trends will likely continue.
According to the Washington, D.C.-based National Association of Real Estate Investment Trusts (NAREIT), the FTSE NAREIT Mortgage REITs Index indicated a 19.89% total return for 2012. In comparison, the commercial financing sector's total return was 42.98%, and the home financing sector returned 16.38%.
Dividends showed strong returns, too. The dividend yield of the FTSE NAREIT Mortgage REITs Index yielded 12.93% at year-end 2012, with the commercial financing sector yielding 8.29% and the home financing sector yielding 13.84%. By comparison, says NAREIT, the dividend yield of the S&P 500 at Dec. 31 was 2.22%.
The three-year average return for mortgage REITs is 12.77% per year, says Brad Case, senior vice president of research and industry information at NAREIT.
‘The mortgage REITs industry is doing very well – better than the S&P 500 index, which averaged 10.87 percent,’ he says, adding that mortgage REITs are benefiting from the end of the liquidity crisis. ‘Freddie Mac and Fannie Mae are holding huge numbers of residential mortgages. Those gigantic balance sheets are going to be brought down over time.’
REITs have access to capital, so they are buying these mortgages. ‘During this period of dislocations, they are buying mortgages at good prices and will continue to for years in the future,’ Case says. He notes that Fannie Mae and Freddie Mac will not reduce their balance sheets to zero, ‘but they will wind them down to manageable levels.’
One factor that might affect REITs is the continued low interest rates. Mortgage REITs profit from the difference between the interest rate of the loans and the interest rate the REITs pay on short-term loans. Case is confident that well-managed REITs can overcome this challenge.
‘The business is a spread business,’ he says. ‘The hard part is choosing a mortgage, making sure you are not taking on too much risk, managing the risk and still earning money.’
Other experts agree that the state of the mortgage REIT industry is good.
‘Looking at real estate REIT performance, the results aren't too shabby,’ says Richard Zahm, director of Trinity Development Fund, based in Boston.
Zahm observes that REITs trend with the fundamentals: as commercial real estate sectors improve, so do REIT returns. ‘So, sectors such as hotels are looking good,’ he says. ‘Apartments are also doing well as vacancies drop and underlying values gain.’
But Zahm cautions that REITs have to be analyzed from the bottom up, which refers to individual REITs and the properties within the portfolios, as well as from the top down, which means broad trends.
‘A single REIT focusing on shopping malls might be doing well overall, even as it turns an underwater mall over to special servicing,’ Zahm says. ‘It really depends on a whole host of factors: the location of properties, their age, and their management, as well as the management of the REIT itself.’
David Toti, senior REIT analyst for New York-based Cantor Fitzgerald, says REITs in general are getting positive attention from investors due to several factors. The election is done, the fiscal cliff attention has ended, Europe has been quiet and economists are positive about gross domestic product and employment for this year.
‘That lifts all boats,’ Toti says. ‘But despite all the good news, we are in a zero-yield world, and global investors are desperate to find returns. Retail works well because it is still underpriced and still attractive. Health care is driven by dividends, and there has been merger and acquisition activity – so there is takeout potential. Storage is driven by phenomenal core growth.’
There are also niche REITs that cover such diverse endeavors as timber, cell towers, prisons and solar power installations. CBS Corp. recently announced it was converting its outdoor advertising business into a REIT. Companies use the REIT structure for favorable tax status – REITs do not pay corporate taxes – but Toti notes that Cantor Fitzgerald does not track these esoteric sectors.
As for the more mainstream REITs, Zahm thinks REITs may enjoy a boost from their new tax treatment. In the past, investors enjoyed high dividend yields, but had to pay taxes according to their tax brackets.
‘With qualified dividend status disappearing, all dividends will be taxed at the same rate,’ Zahm explains. ‘REITs will be treated the same as other types of investments.’
Case adds that REITs have an 18-year cycle. ‘We are not quite four years into the up part of what I expect to be a long real estate market cycle, so the best chances for making money come early in that cycle,’ he says. ‘That's when it is important to have access to capital.’
Nora Caley is a Denver-based freelance writer. She can be reached at firstname.lastname@example.org.