There's good news and bad news for mortgage real estate investment trusts (mREITs). The good news is that the long-awaited housing market recovery may have actually begun, which could mean increased mortgage business. The bad news is that the global economy has entered a downturn, which could spread to U.S. shores sooner or later.
Housing prices actually rose in most American cities in March, the Standard & Poor s (S&P)/Case-Shiller Index indicates. The analysts found that home prices rose in 12 of 20 cities surveyed. The biggest increases were in Dallas, Phoenix, and Seattle. Unfortunately, housing prices were still falling in some cities, such as Detroit, Chicago, and Atlanta.
The combination of rising home values and record low interest rates should drive more people to refinance, or at least try to refinance. That should benefit mREITS like American Capital Agency (AGNC) and PennyMac Mortgage Investment Trust (PMT), which buy up refinanced arms and second mortgages.
The increase in home purchases should help trusts such as AG Mortgage Investment (MITT), Hatteras Financial (HTS), MFA Mortgage Investments (MFA) and Anworth Financial Asset (ANH), which invested in federally-backed mortgages. Since federally guaranteed mortgages are about the only ones left, these firms should see more business.
The upshot of this should be an immediate increase in stock value and earnings per share for some mREITs. The job market is also improving, which means more people should be able to afford to refinance or buy a home. Economists predicted that 160,000 jobs would be added to the U.S. economy in May.
The U.S. Department of Labor's Bureau of Labor of Statistics is supposed to release its job growth report for the month of May on Friday, June 1. If the results of that are good and the 160,000 figure is accurate, mREIT stocks should go up. If job growth does not match that prediction, expect mREITs, like other stocks, to fall. Expect any affect this has on mREITs to be a short lived.
Two Harbors could benefit from Housing Recovery
A stock that could really go up on good news concerning the housing market is Two Harbors Investment (TWO). Two Harbors has been quietly buying up single-family homes in various parts of the country. As of March, it had bought around $6.1 million worth of such homes (presumably foreclosures) as an investment or a hedge against a mortgage collapse.
Unfortunately, we don't know what markets Two Harbors bought in, how many houses it bought, or what it paid for each house. That means this upswing may not help the company, or and could help it because housing values in some markets are still going down, so. So Two Harbors could actually be losing money on that deal.
Residential Construction Recovery could be on Horizon
Long -term growth for home sales and mortgages looks good because the housing market seems to finally be growing again. The Wall Street Journal reported that the Core-Logic analysis firm found that housing prices nationwide are rising at the fastest level since the spring of 2006. The Journal also noted that the Case-Shiller Index indicates that new housing starts in the U.S. had climbed to 700,000 in April 2012 from a low of 500,000 in 2009.
The potential for mREITs from this is obvious - all those new home buyers are going to need mortgages. The logical providers of those mortgages in today's economy are REITS such as Annaly Capital Management (NLY) and Apollo Commercial R.E. Finance (AMTG). Any prolonged housing recovery will boost their stock values.
Global Downturn Could Hurt mREITs Chances of Future Growth
The big danger to mREITs and their stock values is the global economy, which seems to be lurching towards a major downturn. The debt crisis in Greece is beginning to drag the economy in every country in the European Union down. Business activity in Germany (which has long been touted as the world's best economy) is beginning to fall, and the British economy has contracted so much that it could be back in recession.
The situation in Europe is also beginning to affect China - its amount of manufacturing has been slipping for seven straight months. Economies in other nations, including South Africa, are also slipping. There are even worries about a recession in Australia, where the economy has been booming because of high mineral prices. The numbers overseas indicate that a global recession has begun and it is coming here.
The most likely casualty of a new recession will be job growth. Much of the job growth in recent years has been driven by increases in manufacturing. If the Chinese and Europeans stop buying our products, that will lower the number of manufacturing jobs and lead to rising unemployment. Obviously, unemployed people and people worried about job security don't buy homes or refinance mortgages.
Any signs that the recession has reached the United States will hurt mREIT stocks. The growth of these trusts hinges on growth in the mortgage market, if the mortgage market stops growing, or worse, starts contracting, expect high-flying mREIT stocks to drop like bricks.
Those hurt the most will be issuers of government -backed vanilla mortgages, such as Cypress Investments (CYS), Annaly, and Dynex Capital (DX). One company that might see a boost from a new recession could be Annaly's spin-off, Chimera Investment Trust (CIM), which invests in riskier mortgages.
Chimera could benefit because lenders fearing a recession could unload riskier mortgage paper. It could also benefit because the volume of such mortgages could increase.
Larger REITs, such as Annaly and American Capital Group, should be in a better position to survive a recession because they have more resources. They may also have the luxury of investing in those areas of the country that will be less affected by a downturn. Another advantage that the big boys could have is that it will be easier for them to write off losses.
Some of the smaller REITs, such as Hatteras, may not have that luxury. Expect some of them to collapse or be acquired by larger REITs during a recession. The collapse of a single mREIT would definitely cause mREIT stocks to fall.
Another stock that could benefit from recession could be Two Harbors because people will still need a place to live. Unemployment and uncertainty about the economy could drive more families to rent homes, which could increase Two Harbors' cash flow and stock value.
Geography could Determine mREIT Stock Values
A strong possibility is that the coming recession, like the housing recovery, will be geographically varied. Just as housing values are sinking in some areas and rising in others, unemployment will rise and fall in some areas.
The biggest area hurt by the downturn would be the Midwest, including industrial centers such as Detroit. Those regions depend heavily on manufacturing and exports, both of which will be hurt by the global downturn. The S&P Shiller Index indicates that home values in Chicago and Detroit are still falling, so the downturn may have already reached those areas.
This means a very volatile economy and housing situation, which could be very good for mREITs. Mortgage REITS have prospered in the last few years because they have been in a position to take advantage of an extremely volatile housing market. It looks like that volatility is going to continue, which should mean an increased market volume and earnings per share for mREITs.
Unlike traditional financial institutions, these trusts can take advantage of changing conditions and the opportunities they create quickly. Therefore, recession could actually make mREITs bigger and stronger than ever and increase their stock values and dividends over the long run.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.