These 10 mREITs Will Rise On Record Low Rates

by: Ry Frank

Mortgage interest rates have fallen to record lows, a development that should boost mREIT profits and stock prices. On Thursday, Freddie Mac (OTCQB:FMCC) reported that the 30-year mortgage rate in the U.S. had fallen to 3.78%; that's the lowest it has been since they started keeping records back in the 1950s. At the same time, the interest rate for a 15- year fixed rate mortgage had sunk to an astounding 3.04%.

This is definitely good news for mREITs that buy residential mortgages, because they make their money by leveraging funds borrowed against mortgages. The lower the interest rate, the more they can borrow and the more mortgages they can underwrite. This should really help giant mREITs, such as Annaly Capital Management (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC), which have the ability to raise huge amounts of money through offerings.

Annaly, in particular, should really benefit because it just got done raising $1 billion in a round of offerings in May. The largest mREIT is certainly in a great position to take advantage of this situation.

The low interest rate on 15-year fixed rate mortgages is also very good news because those are popular refinancing instruments. Refinancing now makes up the majority of the mortgage business, and mREITs are the major source of capital for refinancing. The lower rates should get more homeowners to refinance, which means even more business for mREITs.

Real estate investment trusts are uniquely positioned to take advantage of the fall in interest rates, because they are among the few institutions capable of raising large amounts of capital for the mortgage market. Not only are they now the largest players in the business, but also in some cases, they are the only players, which means they are the only place mortgage issuers can go for money.

Low Rates Could Keep Competition Away

There is a long -term downside to falling interest rates -- rates could fall so low that nobody could make money by issuing mortgages. If that were to happen, REITs would not be able to leverage mortgages and lose their market. In such a situation, mREIT stock values would quickly collapse and their high dividends would disappear.

mREITs are far more flexible than other lenders, so they should be able to ride mortgage rates to a much lower level. The increase in business created by lower rates and cheaper mortgages could generate enough additional business to enable them to keep leveraging and stay profitable.

At the same time, this low rate could put up a moat that could keep other lenders, such as insurance companies, out of the mortgage business. Entities that need a fairly high rate of return will stay out of mortgages because the profits simply are not there. This situation would only last as long as the low interest rates do.

Rising Home Sales Should Boost mREITs

Home sales are also increasing slightly, which should bring more business to REITs such as Hatteras Financial (NYSE:HTS), AG Mortgage Investment (NYSE:MITT), and Two Harbors Investment (NYSE:TWO). The U.S. Commerce Department estimated that new home sales rose by 3.3% in the month of April.

The best news was in the Midwest and the West, where new home sales rose by 28%. Unfortunately, the gains in the Midwest were offset by a decline in the South, where sales fell by 10.8%. This could mean that depressed housing markets in states like California, and Nevada, are recovering. It also means that the recovery is uneven and demand for homes and mortgages is still low in parts of the country.

Over all, home sales seem to be rising in some areas of the country as well. In the state of Maine, home sales rose by 8.8% in April, which was the ninth consecutive month of increase in home sales volume, the Maine Real Estate Information System reported. That would seem to indicate a recovering housing market, at least in New England.

Total home sales also showed a healthy increase in the Northeast; they rose by 19.2%, according to Maine'sPortland Press-Herald, so. So it looks like a housing recovery may have begun in all of the Northeastern states. Unfortunately, the recovery may not be nationwide.

Sales of both new and used homes in April 2012 were 9.9% higher nationwide, according to the National Association of Realtors. Unfortunately, the recovery in total housing sales seems to be as uneven as that in new home sales.

That could benefit REITs, which can pick and chose where they operate and which mortgages they underwrite. They can concentrate their business in those regions where demand for mortgages is increasing and stay out of the depressed areas.

Any increase in new home sales should benefit REITs that specialize in financing single family homes. That includes Dynex Capital (NYSE:DX) and Cypress Sharpbridge Investments (NYSE:CYS). These companies stock values and profits could see a real boost from the state of the housing industry.

Uneven Housing Recovery Could Help mREITs

Even though housing seems to be recovering, it is far from healthy. Economists estimate that the rate of housing sales is about half that necessary for a healthy recovery. Those terrible stats will undoubtedly keep a lot of lenders out of the mortgage market, which means more business for mREITs.

These statistics should also help mREITs raise more capital in the financial markets, which will put them in a better position to take advantage of the situation. The interesting truth is that a depressed housing market is good for non-traditional lenders such as REITs.

Any recovery is certain to be both volatile and uneven, which is certain to scare off more conservative lenders and investors. Big banks and insurance companies, which were burned by mortgage derivatives during the 2007 meltdown, will be most likely to stay away. Their caution will be increased by the political climate and the public anger over the recent losses at JPMorgan Chase (NYSE:JPM).

This could dig the moat created by low mortgage rates a little deeper, which would give mREITs a bigger share of the business. The biggest beneficiaries would be the biggest and most stable mREITs, such as Annaly and Invesco Mortgage Capital (NYSE:IVR), which offer the most security.

One interesting development would be that banks, insurance companies, investment banks, hedge funds, mutual fund companies, and other entities might try to take advantage of this situation by creating mREITs of their own. They would be attracted by the high earnings per share and dividends REITs like ARMOUR Residential (NYSE:ARR) are offering. Larger mREITs might also create specialized subsidiaries to take advantage of the situation. Annaly has already done this with Chimera (NYSE:CIM).

One logical development here might be mREITs set up solely to finance mortgages in one particular area of the country, such as the Midwest or New England. This is likely to happen if housing recovers in one region, but not in another.

Another might be mREITs organized by entities, such as realty companies or homebuilders, in an attempt to increase the number of mortgages issued. News reports indicate that the mortgage market is tight and many perspective buyers are being turned away. Some realty or home building companies might try to rectify the situation and expand their customer bases by organizing their own mortgage REITs.

The creation of new REITs would be likely to hurt the stocks of existing mREITs and drive down mREIT stock prices in general. Part of the reason why stock prices are low is that the number of these entities is limited. If large numbers of them start cropping up, stock values will fall because the market will become saturated.

On the downside, market saturation is certainly a danger because statistics indicate that the housing recovery is still limited. There is only room for a limited number of mREITs in the current market. If too many enter it, we could see a bubble and collapse.

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