Market expectations for a more modest reduction in the Federal Reserve’s monthly bond purchases were already impacting real estate investment trusts. But now with the Fed delaying its tapering launch, mREITs remain in a state of long-term confusion despite benefits gained from the extended timeline.
The central bank’s delay in tapering its quantitative easing bond-buying program has put the risk of a decision at least another six weeks away.
For instance, Compass Point expected the Fed to taper Treasury purchases, but leave mortgage-backed securities purchases unchanged.
"The lack of any tapering will bias interest rates lower and the mortgage basis tighter," explained Compass Point analyst Jason Stewart.
He added, "Both of which are positive for agency and nonagency mREIT investors."
Although mortgage REIT valuations have improved slightly over the past few trading sessions, the sector as a whole still sits near a historical low when measured on a price/book basis.
The delay in tapering has left mREITs in a funny predicament: a steeper yield curve presents a better net interest spread environment for the sector, but the process of getting there can be challenging for book values for REITs not fully hedged, explained Keefe, Bruyette & Woods analysts Michael Widner and Sean Tillman.
"In the very short term the sharp curve flattening favors less hedged REITs that have sold off sharply," KBW analysts stated.
They added, "Over the medium term, however, tapering expectations will likely continue to hang over the sector and our general bias is toward those REITs more fully hedged."
In a more favorable interest rate environment — despite the higher level of intermediate interest rates — mREITs with a significant investment in nonagency and commercial mortgage-backed securities will remain the leaders of the sector in the short term, pointed out Compass Point.
Investors should look for companies that can produce stable core earnings on a through-cycle basis and have some upside to book value of equity per share in a tighter spread and lower rate environment.
Additionally, the firms should be priced well below historical average multiples.
Stepping back, mREITs still produce double-digit yields and trade at sizable discounts to book.
Furthermore, if book values hold flat at depressed levels, industry experts remain positively positioned despite rate uncertainty.
Fed MBS purchases are negative for mREITs due to spread compression, but scaling back purchases is worse because of declines in book values.
However, the biggest threat to the sector is not knowing at all when the central bank will begin to scale back it’s bond-buying program.
"The challenge is QE has destroyed market confidence," KBW analysts said, adding that no one knows where rates ‘belong'.
This type of environment can make it "very difficult for mREITs to hedge," the analysts concluded.
