What is a Mortage REIT?

What is a Mortage REIT?

Manual Guide of Mortgage REITs

Mortgage Real Estate Investment Trusts, also called Mortgage REITs or MREITs, are companies that, like their Collateral REIT cousins, were made possible through legislation passed by Congress in 1960 to assist enable individuals from all walks of life to gain the advantages of investment in real estate debt and equity.

Congress specifically noted these beneficial characteristics include “greater diversification of investment, ” “expert investment counsel” and also the means of “collectively financing projects which the investors could not really undertake singly. ”

A key part of the original REIT legislation requires REITs in order to distribute most of their income each year to their shareholders as dividends. REITs are permitted to deduct from their corporate taxable income every dollar they shell out, while shareholders pay tax on the dividend income they obtain, generally at ordinary income tax rates. This dividend distribution requirement is fundamental towards the ability of REITs to deliver the continuing income and performance benefits characteristic of property debt and equity investment.

The Mortgage REIT Industry: A Varied Marketplace

There are two main types of REITs, generally known as Mortgage REITs and Equity REITs. Mortgage REITs provide financing for property by purchasing or originating mortgages and mortgage-backed securities (MBS) and earning income in the interest on these investments, while Equity REITs invest in property equity by acquiring properties – such as shopping malls, office buildings or apartments – and collecting rents using their tenants.

Mortgage REITs invest in residential and commercial mortgages, in addition to residential mortgage-backed securities (RMBS) and commercial mortgage-backed investments (CMBS). Mortgage REITs typically focus on either the actual residential or commercial mortgage markets, although some invest in each RMBS and CMBS.

Most residential Mortgage REITs invest in “agency” RMBS, that are issued by Fannie Mae and Freddie Mac, often referred in order to as U. S. government-sponsored enterprises (GSEs), or Ginnie Mae. Agency RMBS constitute the majority of assets held by Mortgage REITs today. However, residential Mortgage REITs also may purchase RMBS issued by other financial institutions (non-agency or private-label RMBS) and residential home loans.

Commercial Mortgage REITs provide financing for commercial real estate. They might invest in commercial mortgages and commercial real estate loans, in addition to both rated and unrated CMBS, mezzanine loans, subordinated securities or even construction loans, and may participate in loan securitizations.

Mortgage REITs are usually listed on the NYSE or NASDAQ, allowing a wide selection of investors, including individual investors as well as institutions, to purchase shares of the equity securities. Stock exchange-listed Mortgage REITs provide a simple method to hold an equity investment in the mortgage market with the actual liquidity and transparency of publicly traded equities – advantages unavailable through direct investment in mortgage loans and mortgage-backed securities. By June 30, 2016, there were 27 listed residential Mortgage REITs having a market capitalization of $41. 7 billion and 15 listed commercial Mortgage REITs having a market capitalization of $16. 2 billion.

There are other Mortgage REITs whose shares are registered using the SEC but are not listed on any stock exchange. These public non-listed REITs (PNLRs) are usually sold to investors by a broker or financial advisor. Mortgage REITs may also be privately held.

Mortgage REITs

The Mortgage REIT Business Model
Mortgage REITs hold mortgages and MBS on the balance sheets, and fund these investments with equity and financial debt capital. Their general objective is to earn a profit using their net interest margin, that is, the spread between interest income on the mortgage assets and their funding costs. Mortgage REITs rely on a number of funding sources, including common and preferred equity, repurchase agreements, organised financing, convertible and long-term debt, and other credit facilities. Mortgage REITs raise both debt and equity within the public capital markets. Mortgage REITs raised $84. 8 billion as a whole equity offerings between 2005 and June 2016.

Mortgage REITs typically use less borrowing and much more equity capital to finance their acquisitions of mortgages and MBS compared to do other large mortgage investors. At June 30, 2016, the asset weighted average equity capital ratio of stock exchange-listed Mortgage REITs was 13. 8 percent, compared in order to 9. 6 percent for the commercial banking industry and 7. 5 percent for that investment banking industry. Mortgage REITs were also typically better capitalized than other mortgage investors within the period before the 2008 financial crisis.

Investing in Mortgage REITs
Investors typically find value in Mortgage REITs primarily for their relatively high dividends.

There are several ways to invest within Mortgage REITs. Investors can purchase common or preferred shares associated with individual stock exchange-listed MREITs, most of which are traded on major stock exchanges such as the NYSE or NASDAQ. Direct purchases provide the liquidity of publicly traded securities along with the ability to choose which individual REITs to include in the actual investor’s portfolio. Alternatively, investors can purchase shares in a mutual fund that targets Mortgage REITs. This strategy helps provide diversification across the entire sector while still allowing sales and exchanges with an end-of-day basis. Investors can also purchase shares in a Home loan REIT exchange-traded fund (ETF), which provides additional liquidity through a chance to buy or sell shares during the trading day.

Each of those strategies – direct purchases of shares of individual Mortgage REITs, investing via a Mortgage REIT mutual fund or through a Mortgage REIT ETF – allows investors to keep an equity investment in the residential and commercial mortgage marketplaces.

Risks and Risk Management
The business risks that Mortgage REITs face act like those of other financial firms. Mortgage REITs have considerable experience managing various kinds of risk:

Interest Rate Risk. Managing the effects of changes in short- and long-term rates of interest is an essential element of Mortgage REITs’ business operations. Changes in rates of interest can affect the net interest margin, which is Mortgage REITs’ fundamental supply of earnings, but also may affect the value of their home loan assets, which affects corporate net worth.

Mortgage REITs typically manage and mitigate risk related to their short-term borrowings through conventional, widely-used hedging strategies, including rate of interest swaps, swaptions, interest rate collars, caps or floors and additional financial futures contracts. Mortgage REITs also manage risk in different ways, such as adjusting the average maturities on their assets in addition to their borrowings and selling assets during periods of interest rate volatility to boost cash or reduce borrowings.

Credit Risk. The bulk of mortgage securities purchased by residential Mortgage REITs are agency securities backed by the us government, which present limited credit risk. Commercial Mortgage REITs may come in contact with credit risk through their private-label RMBS and CMBS. The level of credit risk for a particular security depends on the credit performance from the underlying loans, the structure of the security (that is actually, which classes of security are paid first, and which tend to be paid later), and by the degree of over-collateralization (where the face amount of the mortgage loans held as collateral exceeds the face area amount of the RMBS or CMBS issued).

Prepayment as well as Rollover Risks
Prepayment. Changes in interest rates or borrower house sales affect the probability that some borrowers will refinance or even repay their mortgages. When such a refinancing or repayment happens, the investor holding the mortgage or MBS must reinvest the proceeds to the prevailing interest rate environment, which may be lower or greater. Mortgage REITs seek to hedge prepayment risk using similar resources and techniques as those they use to hedge against rate of interest risks.

Rollover. Mortgage REIT assets are mainly longer-term MBS as well as mortgages, while their liabilities may include a significant amount associated with short-term debt, especially among residential Mortgage REITs. This term mismatch requires they roll over their short-term debt before the maturity of their own assets. Their ability to do so depends on the liquidity and smooth functioning from the short-term debt markets, including the repo market. The repo market is very liquid, with an estimated $2 trillion in outstandings and a number of hundred billion dollars in daily trading volume. Banks and dealers also make use of the repo market as an important source of market liquidity. Within the financing markets, the liquidity of the agency MBS and TBA (To Be Announced) markets resembles the market for Treasuries. Commercial Mortgage REITs tend to match the duration of the assets and liabilities and face little rollover risk.

Benefits in order to Homeowners, Businesses and Financial Markets

Mortgage REITs provide funding with regard to mortgage credit for both homeowners and businesses. By using private capital to purchase residential mortgages and mortgage backed securities (RMBS), Mortgage REITs help provide liquidity and credit to mortgage markets. Their financing activities have helped provide mortgage loans for just two. 5 million homebuyers. Likewise, Mortgage REIT purchases of commercial mortgages and commercial mortgage-backed securities (CMBS) provide another supply of mortgage credit for business investments in commercial real estate.

Mortgage REITs are situated to play an important role in the post-financial crisis restructuring from the housing finance market. Most blueprints for mortgage market reform require a significantly reduced role for Fannie Mae and Freddie Mac. Refinancing the home loans and RMBS currently owned by the GSEs, as well as funding new mortgage originations for future homebuyers will need large sources of new capital, particularly as the GSEs and also the Federal Reserve reduce their investment activities. Mortgage REITs have a chance to raise private capital without government guarantees or reliance on FDIC-insured financial institution deposits. Most Mortgage REITs are registered with the SEC and have to publish regular financial statements for review and monitoring by traders and analysts. Through their ongoing provision of residential and industrial mortgage credit, Mortgage REITs continue to play an important role within the recovery of housing markets and overall economic growth.

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