Mortgage REITs: Ignore GAAP, It's All About the Cash

Mortgage REITs manage their businesses based on long-term opportunities to earn cash flows. Their common stock dividend distributions are driven by the REIT tax laws and their taxable income as calculated pursuant to the IRS tax code. Their reported results for GAAP purposes differ materially, however, from both their cash flows and their taxable income.

The earnings releases today highlight just how useless GAAP currently is for evaluating a mortgage REIT's financial performance. Just by adopting FAS 159 on January 1, RAIT Financial's (RAS) GAAP book value jumps from $6.78/share to $23.35/share, simply by virtue of being able to mark its CDO liabilities to market. (RAIT also benefited from the deconsolidation of certain variable interest entities, but that's a completely separate rant.)

The write-downs, write-ups... it's sound and fury, signifying nothing for most of the mortgage REITs. I've stopped worrying about the bottom line number and turned my attention instead to the availability of liquidity in the marketplace. The lack of liquidity, as I noted in an earlier post about Newcastle Investment (NCT), is prohibiting investment growth and pressuring future taxable income.

Many of the diversified REITs have had to resort to asset sales to boost cash, including Deerfield Capital (DFR), which sold $1.5 billion in RMBS during the fourth quarter. Newcastle dumped $1.3 billion in assets during Q1 2008, and RAIT sold an undisclosed amount of RMBS during Q4 2007. Even iStar Financial (SFI) wound up selling off its investment in a timber JV.

The bigger question is from where will the financing for portfolio growth come going forward. RAIT and NorthStar Realty (NRF) both seem to be headed to the bank to seek term credit facilities. iStar is moving to encumber its net lease portfolios. Everyone is scrounging for liquidity in a post-securitization market. The survivors will be those who can adapt enough to find alternate sources of liquidity and take advantage of the less-competitive landscape going forward.

Disclosure: I'm long RAS.

Comments

[thesession:]

Hearing tons of margin calls going out to Mortgage REITs today... could be trouble.

2008 Feb 29 08:43 AM

[siegfried:]

If the particular REIT is not going bankrupt i.e. there are no short term financing issues, and yielding over 15%, then reducing assets and buying back stock makes financial sense. Basically buying back dollars for 85 cents. There is opportunity in panic.

2008 Feb 29 10:22 AM

[leviticus1935:]

The best of them all is CapitalSource, yielding 15 percent with plenty of liquidity. CSE has maintained good credit quality and the CEO talks about many opportunities to lend at wide spreads.

2008 Feb 29 11:04 AM

[johnthebear:]

While REITs without mortgages (all cash ownership) might not be affected directly by the margin calls mentioned above, it is but a matter of time till asset sales which reflect higher capitalization rates can have an effect when the assets of equity REITs are marked to market, using both comparable sales as well as the income approach to value.

At that point in time, the speculative rent increases and assumed appreciation should knock the socks off all the REITs.

2008 Mar 02 05:50 PM

[Jimis my name:]

Great article. Another Fed Rate Cut will really have money looking for a place to invest. Almost all mortgages are still great paper.

2008 Mar 05 04:15 PM