7 Small Cap Commercial Mortgage REITs and Their 2011 Performance

by: Zvi Bar

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 ones, of agency or non-agency breed, should hold residential mortgages on houses and apartments.

Commercial mortgage REITs also tend to be on the smaller side, often as a small-cap ($300 million to $2 billion) or a micro-cap ($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.

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 to a majority. Many of these REITs can change their mortgage asset mix, and have in the past. The group offers yields ranging from zero to over 15%, and several with values near or well below book.

  1. Colony Financial (NYSE:CLNY)
  • Current Yield: 7%
  • Market Value: $590 million
  1. CreXus InvestmentCorp. (NYSE:CXS)
  • Current Yield: 9.1%
  • Market Value: $833 million
  1. iStar FinancialInc. (SFI)
  • Current Yield: None
  • Market Value: $715 million
  1. NorthStar Realty Finance Corporation (NRF)
  • Current Yield: 10.4%
  • Market Value: $312 million
  1. Newcastle Investment Corp. (NCT)
  • Current Yield: 7%
  • Market Value: $397.5 million
  1. Resource Capital Corp. (RSO)
  • Current Yield: 15.3%
  • Market Value: $464 million
  1. Starwood Property Trust Inc. (NYSE:STWD)
  • Current Yield: 8.8%
  • Market Value: $1.43 billion
Several of these REITs have large short positions. Many investors believe an interest rate change, or second real estate correction will reduce the value of the underlying properties and increase the probability of greater defaults. Moreover, higher rates will make it less profitable for future tenants to occupy commercial space, possibly keeping higher vacancies for an extended time-frame. Since the start of 2011, these REITs lost between 1% and 17%:

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Over the last quarter, the group declined between 5% and 23%:

And over the last month, these commercial MREITs lost between 2% and 9%, except NCT, which appreciated over 7%, after declaring its dividend.

Nonetheless, NCT is still down 15% for the year, as the first chart indicates.

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 exposure may compliment an income portfolio well.

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