Fannie and Freddie Reorganization Adds Volatility to REITS Stocks

by: The Simplified Investor

The government takeover of Fannie Mae (FNM) and Freddie Mac (FRE) will have far-reaching economic effects.  For example, hedge funds that bet against the two companies have already seen windfall profits as the stock prices of both companies plummeted over the weekend, while the financial institutions that invested in the nearly $5 trillion in mortgages and mortgage-backed securities that FNM and FRE guarantee can breathe a sigh of relief. 

The government bailout should help avoid a global financial crisis - but it might not help all of the Real Estate Investment Trusts (REITs) that depend on loans from Fannie and Freddie to finance their growth.

REITs are corporations that pool investor capital to purchase either income property or mortgage loans.  An example of the former is Simon Property Group (NYSE:SPG), which owns strip malls and shopping centers throughout the United States. The latter group includes companies like Annaly Capital Management (NYSE:NLY), which invests in mortgage-backed securities - collections of individual mortgages that are packaged and sold to investors by banks and mortgage lenders.  Any REIT depends on loans in order to buy new mortgages, or to build new properties (depending on its business model), and Fannie Mae and Freddie Mac are key lenders in this industry.


When the government bailout plan was announced Friday, many REITs saw their stock prices jump.  Annaly, for example, jumped nearly 15% over the weekend. 

Annaly specializes in buying mortgage-backed securities guaranteed by the government, a market that had been viewed as low-risk but became more volatile in 2008 as the long-term future of Fannie and Freddie was clouded with doubt.  It’s pretty clear that government intervention will allow Annaly and its closest competitors (including America First Mortgage Investments and Capstead Mortgage) to survive and continue to invest in mortgages backed by the government. 

A cause for optimism is the Treasury Department’s stated intention to start buying up mortgage-backed securities on the open market, boosting the plummeting prices of these bonds; one analyst estimates that this new action will boost Annaly’s book value by nearly 10%.

What’s less clear, however, is whether Fannie and Freddie will continue to lend to residential REITs, including those that invest in apartments and multifamily housing.  Companies like Equity Residential (NYSE:EQR) and Camden Property Trust (NYSE:CPT) depend heavily on Fannie and Freddie to finance their growth by purchasing groups of apartment loans. 

As the feds decide which of Fannie and Freddie’s businesses to retain, and which to dissolve, these companies could be impacted in several ways.  The government may decide to scale back this line of business, lending less capital to these companies; or, it might make it easier for families to finance loans for single-family houses, making renting a less attractive option and indirectly hurting the apartment business. 

Apartment REITs can take solace in numbers, however - Fannie and Freddie’s market share in multifamily financing has grown to over 90% from less than 50% in 2007 as other lenders shy away from real estate.  Furthermore, apartment lending has become the only profitable line of business for both companies lately - Fannie’s delinquency rate for multifamily loans has been 0.11% in the past year, compared to a 1.36% rate on loans for single-family housing.

Whatever decisions the government makes, in the short term investor uncertainty has led to a pullback in REIT stocks.  On Tuesday the Dow Jones Equity REIT index fell 4.1%, giving back almost all of the 4.7% it gained over the weekend.  The 116 REITs in the Dow index own a variety of real estate properties and related assets, and they won’t all be affected the same way by the government’s actions with Fannie and Freddie.  But in a market as volatile as real estate in 2008, there are no sure things, and REIT investors should watch their stocks (and the news) carefully as the historic takeover takes shape, and the government’s true intentions become clear.

Disclosure: None