(04-10-2015, 06:27 PM)hendi_alex Wrote: To me the main problem/headwind lies in financing costs. As those costs increase, REITs will lose margin and cash flow. IMO that aspect is not noise. My approach will be to slowly accumulate over varios cycles. There is no compelling reason to go full pool during what is the most favorable part of the cycle, a time when yields are historically low on the strongest REITs.
What you say about REITs and margins is relevant to mortgage REITs but not equity REITs. In a rising rate environment, equity REITs typically prosper because rising rates are the result of increased economic activity, which is all to the good for these. Additionally, equity REITs use mostly fixed rate financing, so rising rates will have little negative financing expense effect on them.
For these reasons, I have one mortgage REIT in this portfolio but a lot more than one equity REIT.
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Property REITs generally have lots of various financing, some fixed rate and some adjustable. Maturity dates vary as well, with most not going out much beyond 5 years. As debt has to be rolled over, higher rates for the new term will bite into margins. Be sure to look at the specific borrowing details for each REIT that is held. Some will have a pretty good buffer to rising rates, others will have a lot of near term maturities, therefore will be more vulnerable to rate increases.
For MREITS short term borrowings are constantly having to be rolled over. That plus degree of leverage makes them particularly vulnerable. As you point out, much more risky than property REITs.
Alex
One more thought on mortgage REITs. My portfolio owns CMO, which invests in ARMs (adjustable rate mortgages). At least in theory, as long rates rise, these should not lose market value, and at the same time should receive increased interest income. Thus increased short term borrowing costs should be offset by increased interest income, and NAV should not be negatively affected.
In theory. We will see.
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There are twp problems with that scenario. First the resets always trail the rise in short term borrowing rates. Some times short borrowings and long term rates invert, so no resets then. During rising rates there may also be lots of refi's into fixed rate, and those prepays kill the portfolio held by the MREIT. Quite a few really good ARMs lenders went under or very nearly went under during the last rising rate cycle. Resets and hedges were almost no help. IMH, NFI, TMA were considered by many to be among the best of the breed. TMA is gone and NFI and IMH are less than 1/10 of their former value.
Alex
(04-10-2015, 08:06 PM)hendi_alex Wrote: There are twp problems with that scenario. First the resets always trail the rise in short term borrowing rates. Some times short borrowings and long term rates invert, so no resets then. During rising rates there may also be lots of refi's into fixed rate, and those prepays kill the portfolio held by the MREIT. Quite a few really good ARMs lenders went under or very nearly went under during the last rising rate cycle. Resets and hedges were almost no help. IMH, NFI, TMA were considered by many to be among the best of the breed. TMA is gone and NFI and IMH are less than 1/10 of their former value.
CMO is 100% agency ARMs, so there is no default risk, thus no risk of failure.
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04-11-2015, 07:46 AM
(This post was last modified: 04-11-2015, 07:47 AM by hendi_alex.)
That is a naive view, IMO. MREITs don't usually fail because of defaults. They fail because of yield compression or yield inversion or they fail because mark to market for assets falls and causes covenant breaches. If mark to market becomes the issue, then the lender will own the agency paper and the REIT will no longer be in business.
None of the REITs cited IN THE PREVIOUS POST failed because of defaults. Margins were being squeezed, but mark to market and covenant breaches is what got them.
While agency paper has an implicit guarantee against default, the value of CMOs(collaterized mortgage obligations) vary depending upon market demand. The income that the holdings kick out are purely dependent upon the spread between the average lending rate received by the REIT and the short term borrowing rate tat the REIT has to pay for borrowings against the asset. As pointed out above, both of these present a serious level of risk, even to holders of agency paper.
Alex
(04-11-2015, 07:46 AM)hendi_alex Wrote: That is a naive view, IMO. MREITs don't usually fail because of defaults. They fail because of yield compression or yield inversion or they fail because mark to market for assets falls and causes covenant breaches. If mark to market becomes the issue, then the lender will own the agency paper and the REIT will no longer be in business.
None of the REITs cited IN THE PREVIOUS POST failed because of defaults. Margins were being squeezed, but mark to market and covenant breaches is what got them.
While agency paper has an implicit guarantee against default, the value of CMOs(collaterized mortgage obligations) vary depending upon market demand. The income that the holdings kick out are purely dependent upon the spread between the average lending rate received by the REIT and the short term borrowing rate tat the REIT has to pay for borrowings against the asset. As pointed out above, both of these present a serious level of risk, even to holders of agency paper.
Non-agency mREITs failed during the financial crisis because their book was marked down due to default risk. The mREITs that PROSPERED were the agency mREITs.
CMO is the stock symbol of Capstead Mortgage. CMO does not invest in the CMOs that you referred to.
The only real risk that I see is a flattening yield curve. However, it is instructive to look at the history of NLY. The last time the slope of the yield curve went negative, NLY continued to pay a dividend.
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They were not marked down because of default risk per se. They were marked down because the underlying assets, the houses themselves, had lost value. TMA's jumbo loans generated great clients with high down payments and very low default rates. The value of the houses dropped, tHe value of mostly illiquid mortgage products dropped, covenants were breached, TMA's lenders feasted.
The claim of prospering goes pretty far, as NLY trades at less. than half of its pre 2008 highs. They did survive in part because the market for agency paper stayed relatively liquid, though for a long time was seriously depressed.
I may have used the term collaterized debt obligation wrong. If not mistaken, the originators bundle loans into packages with segments having various credit profiles. The bundling usually gives a pretty high overall rating. The originators either retain these bundles of loans or they sell them, usually retaining some kind of management/servicing fees.
Alex
(04-10-2015, 07:47 PM)hendi_alex Wrote: Be sure to look at the specific borrowing details for each REIT that is held. Some will have a pretty good buffer to rising rates, others will have a lot of near term maturities, therefore will be more vulnerable to rate increases.
Take Realty Income (O) as an example. It has the following debts according to the 2014 10-K:
$223M credit facility
$836M mortgages
$70M term loan
$3.8B unsecured notes and bonds; maturity dates range from 2015 to 2035
Offsetting the various maturities are lease expirations that occur every year through 2043. As the leases expire, O has the opportunity to offset possible increased debt expenses with increased lease income.
Anyone who is interested in an equity REIT should read the 10-K for this type of information.
When is this supposed increase in interest rates going to happen? Folks have been calling for it for years, and missing investment opportunities out of fear. So far, every prediction has been wrong. Short rates are still close to zero and 10 year rates are persistently close to all time lows. The SNB is now charging negative deposit rates. If this is any indication, rising rates are far away.
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