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Generally, there is an industry divide between residential mortgage REITs and commercial mortgage REITs. Commercial mortgage REITs should hold mortgages on commercial properties such as office, retail, medical, industrial and warehouse buildings, while residential mortgage REITs hold residential mortgages on houses and apartments.

Commercial mortgage REITs also tend to be on the smaller side, often small-caps ($300 million to $2 billion) or micro-caps ($50 to $300 million). Commercial real estate is believed by many to hold the greatest risk within the mortgage REIT industry, and possibly within the financial and real estate sectors that it straddles. The fear, here, would be that some commercial centers may suffer high vacancy rates for extended periods of time.

Several investors are still expecting commercial real estate to sustain its own separate, subsequent and consequential fall on the back of failing businesses and a lack of new commercial business coming in to replace them. Many bad loans and bad tenants complicate the industry, and history indicates that commercial real estate often suffers its own subsequent decline following one in the residential real estate market.

Below are seven small-cap REITs that have exposure to commercial mortgages, though not necessarily exclusively or in the majority. Many of these REITs are able to change their mortgage asset mix, and have in the past. The group offers yields ranging from zero to over 15%, and several have equity valuations at or well below book.

  1. Colony Financial (NYSE:CLNY)
    • Yield: 9.45%
    • 1-month: 5.44%
    • 6-month: -24.50%
    • 1-year: -25.71%
  1. CreXus Investment Corp. (NYSE:CXS)
    • Yield: 13.17%
    • 1-month: 5.80%
    • 6-month: -19.23%
    • 1-year: -22.64%
  1. iStar Financial Inc. (SFI)
    • Yield: N/A
    • 1-month: 4.46%
    • 6-month: -30.67%
    • 1-year: 86.09%
  1. NorthStar Realty Finance Corporation (NYSE:NRF)
    • Yield: 11.49%
    • 1-month: 4.82%
    • 6-month: -30.39%
    • 1-year: -22.32
  1. Newcastle Investment Corp. (NYSE:NCT)
    • Yield: 13.88%
    • 1-month: -0.92%
    • 6-month: -29.76%
    • 1-year: 10.19%
  1. Resource Capital Corp. (NYSE:RSO)
    • Yield: 18.86%
    • 1-month: -4.50%
    • 6-month: -16.67%
    • 1-year: -17.82%
  1. Starwood Property Trust Inc. (NYSE:STWD)
    • Yield:
    • 1-month: 6.08%
    • 6-month: -17.44%
    • 1-year: -9.25%

Several of these REITs have large short positions. Many investors believe potential coming interest rate increases and/or second real estate correction will reduce the value of the underlying properties and increase the probability of greater defaults and commercial bankruptcies. Moreover, higher rates will make it less profitable for future tenants to occupy commercial space, possibly keeping higher vacancies for an extended timeframe. Since the start of 2011, these REITs lost between 14% and 35%. See the 2011-to-date chart below. Click to enlarge:

Generally speaking, this industry should probably not represent a large portion of any portfolio that is invested with the prudence required to maintain a fiduciary duty. Nonetheless, as secure fixed income is no longer so secure, and so much of the real estate market has sustained significant losses over the last five years, some commercial mortgage exposure may be one way to supplement fixed income and real estate allocations within long-term portfolios.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article is intended to be informative and should not be construed as personalized advice, as it does not take into account your specific situation or objectives.

Source: 7 Commercial Mortgage REITs: Recent Performance Review