Mortgage REITs (henceforth referred to as mREITs) are an interesting investment sector with periods of both exceptional performance and devastating crashes. These investments are typically broken down into two categories; agency mREITS and commercial mREITs, each of which have their advantages. This article will be focused on the commercial mREITs. When the financial markets are healthy, each tends to thrive, so the aspect that most differentiates these companies is their abilities to handle adverse situations. Specifically, we will be looking at how each one handled the financial crisis and how well they maintained their dividends (or didn't).
Commercial mREITs can be further broken down into legacy companies and new ones. As this article is focusing on disaster preparedness, it will only cover those which were around through the Great Recession. This narrows the field to 5 companies of interest
- Gramercy Capital formerly traded as GKK now known as Gramercy Property Trust (GPT)
- Arbor Realty Trust (ABR)
- Newcastle Investment (NCT)
- RAIT Financial (RAS)
- Northstar Realty Finance (NRF)
We will proceed by looking at each individually to see how they handled the financial crisis.
Gramercy Property Trust
Gramercy was among the hardest hit by the recession. It was forced to suspend its dividend in 2008 and has not been able to reinstate it. Additionally, the company's balance sheet has been hit hard with its book value dipping below zero. Recognizing that it needed a change of pace, GKK hired a new management team and switched directions becoming an equity REIT. Reflective of this change was the new name and ticker Gramercy Properties Trust and GPT respectively. Its equity portfolio appears to have some potential, but its book value is still held below zero by underwater financial assets.
Arbor Realty Trust
Arbor did fairly well in the downturn. It executed 2 intelligent maneuvers that allowed it to save its skin.
- Repurchasing and retiring its debt at substantial discounts
- Recycled the capital from its positions which had not crashed.
A major downside of commercial mREITs is that market prices of securities will directly affect their equity value and consequently debt covenants. This can create a spiral in which the reduced market price of its securities hurts it book value which in turn leads to further reduction in market price. As the book value and market price of Arbor dropped, its CDO debt and recourse debt began to look less secure and traded at deep discounts. This discount was exaggerated far beyond the minimal drop to the intrinsic value of its recourse and CDO debt. Recognizing the disparity, ABR bought its debt back and realized material gains. I believe it was these maneuvers that allowed them to mitigate damage and ultimately reinstate the now increasing dividend.
Newcastle's performance during the great recession provides an excellent example of the difference between market performance and fundamental performance. If we take a look at their book value over time we can see that they got as low as negative $48.23/share.
Such a debt would be insurmountable if it were real. However, nearly all of the supposedly lost book value was from unrealized losses as the market value of their securities dropped.
All NCT had to do to recover its book value was either wait for the market price of the securities to go back up or to hold them until maturity and get the principal back. Its book value has now returned to positive territory and its dividend returned as well.
While RAS's mortgage portfolio has diminished, it has found a place as a property owner. Around 2007 RAS began investing heavily in non-loan assets. This practice stuck and its diminishing interest spread income is being replaced with rental revenues. Thus far, the balance of the two has been sufficient to re-initiate and repeatedly increase its dividend. Although the dividend is much smaller than it was pre-recession, the market price is as well so it still represents a strong yield of 5.56%.
Northstar Realty Finance
Northstar Realty Finance was the only commercial mREIT to pay a dividend through the entirety of the great recession. How was NRF able to do this in such a challenging environment? Well, much like Arbor, NRF took advantage of discounted prices to buy back its own CDO accretively. This maneuver, along with relatively lower leverage at only 1.32 debt/equity to close 2008 allowed NRF to survive with minimal damage. Its superior footing coming out of the recession has allowed it to make substantial equity purchases along with high return financial investments. Together, these provide sufficient CAD to fuel a rapidly growing dividend. NRF's superior performance through the Great Recession is reflected in its long term total returns.
The take away
These companies are far too complex to understand in a brief overview like we have provided today. However, knowing the history of the sector and the relative performance of the prominent players is a great foundation for deeper analysis. Each of these companies is worthy of more focused study, but NRF seems to be the positive outlier with superior scrappiness in adverse situations. I will provide a full focus article analyzing it in the coming days.
Disclosure: 2nd Market Capital and its affiliated accounts are long NRF and NCT. I am personally long NRF. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.