Overall, the real estate market is one of the few that has not recovered from the collapse in stock prices in 2020. Although home sales and prices are strong, there are over 600,000 loans. seriously delinquent mortgages and over 2.5 million active forbearance plans. As detailed in “KBWY: Value Trap As REITs Face Permanent Structural Changes,” the commercial real estate market is a mess with many homeowners struggling with moratoriums on evictions and a slump in demand for retail businesses. and now offices.
Simply put, the real estate market is only surviving because of the extreme drop in mortgage rates last year, which artificially boosted demand and fiscal stability. This was achieved thanks to the Federal Reserve’s aggressive mortgage-backed securities purchase program, which pushed mortgage rates to record highs. While this is an encouraging factor, long-term rates have risen in recent months and the mortgage market is expected to follow suit.
In April, the millions of US homeowners who are forbearing must quit their plan, although Biden can see this date pushed back to September. This will most likely lead to an increase in non-performing mortgages on the balance sheets of banks and REITs. It will also cause Fannie Mae (OTCQB: FNMA) and Freddie Mac (OTCQB: FMCC) to have a significant decrease in cash flow, as they guarantee many of these mortgages. Properties are expensive again and many homeowners in debt are struggling to make their payments. Quite frankly, we may see a repeat of the 2007-2010 scenario in the mortgage market.
In my opinion, this could create significant volatility for mortgage REITs as shown by VanEck Mortgage REIT (MORT). To review, a mortgage REIT is a business that borrows money (usually near LIBOR) and purchases mortgages. Essentially, mREITs are banks that focus exclusively on mortgages and typically operate with high leverage and pay very high dividends. Many of these mortgages are guaranteed by Fannie Mae and Freddie Mac, but this “guarantee” is far from guaranteed since they may not be bailed out again despite the guardianship.
A look at post-COVID mREITs
Currently, MORT has an attractive TTM dividend yield of 7.8%, however, he has had to cut his payouts over the past year due to declining cash flow in his holdings. Many mREITs were forced to sell their assets during last year’s crash, causing liquidity to drain from residential mortgage-backed securities – the core assets of many leading mREITs. The situation was ultimately saved by the Federal Reserve, which bought over $ 600 billion in mortgages from mREITs and near-failing banks.
The situation over the past year has been eerily similar to that of 2007-2008. The main difference is that the Federal Reserve and US lawmakers are a little more seasoned in their methods of dealing with mortgage crises.
While the liquidity front is almost guaranteed by the Fed, the central problem for homeowners of not making payments remains. Despite the progress, still, about 5% of mortgages are overdue by four or more payments. This level could increase with the end of unemployment benefits for many, especially if the labor market remains weak.
In my opinion, while the economy may continue to rebound, it will not return to where it was. The habits, beliefs, desires and interests of many consumers have changed. It is difficult to say exactly what economic changes this will bring about, but it is likely that many jobs and industries will become less viable due to a permanent decline in demand. Eventually, new jobs and industries will emerge as always. However, investors may want to prepare for a period of economic transition that could lead to a multi-year recession / depression as people find out that the jobs they left no longer exist or the company they are in. returned is no longer viable.
Can the Federal Reserve Save the Market?
Given the general opinion of most majority lawmakers and the President, efforts will likely be made to prevent people from being evicted from their homes. As has been the case, the Federal Reserve’s liquidity supply will be used. However, this liquidity supply is limited by rising inflation expectations. If inflation continues to rise at its current rate, the Fed will likely be forced to cut QE and potentially raise rates even if it’s bad for the economy in order to stop the risk of hyperinflation.
Today, mortgage rates continue to fall, but they are now essentially at the same level as inflation expectations. This has never been the case in the recorded history of mortgage rates in the United States. See below :
This is a strong sign that the Fed’s supposed firepower to provide “unlimited” liquidity to the mortgage market may wane when it is most needed. If the Fed becomes unable to print more mortgage money, Mortgage REITs may be forced to take the plunge because Fannie and Freddie are, in my opinion, entirely dependent on this government support to secure the dominant mortgages held in most mREITs.
Given this, it is entirely possible that we will see a repeat of the mortgage liquidity crisis like the one of 2008 that caused financial turmoil for mREITs. At the time, the Federal Reserve’s ability to support the market was much stronger. The Fed was then discovering its true capacities through QE. Today, I think its capacities may be dangerously overexaggerated, which could cause problems for mortgage REITs and banks.
The bullish case
My basic opinion of mortgage REITs is bearish. It is difficult, if not impossible, to predict how bearish this is because it depends on the decisions of a handful of individuals. However, I don’t think the current administration or the majority leadership will object to private companies like mREITs failing in order to stop the mass evictions. Simply put, if the Federal Reserve stops supporting the mortgage-backed securities market, many mREITs could go bankrupt under the weight of their extreme leverage.
Having said that, there is still a possibility that the market will recover. Most mortgage REITs are very cheap, with DEAT trading at a weighted average price to book ratio of 0.93X, meaning many are likely trading below their net asset value. The 7.8% dividend yield is also attractive, and its yield could increase if mortgage REIT dividends return to pre-COVID levels.
In my opinion, if inflation expectations stop rising and fall slightly, then the Federal Reserve will have sufficient capacity to effectively bail out the mortgage market. It is also possible that my opinion that the permanent economic changes resulting from COVID will lead to high and prolonged unemployment is wrong. If so, we can expect the millions of delinquent and delinquent mortgages to make missed payments and relieve Fannie and Freddie of the risk of a liquidity crunch.
Either of these two scenarios would be bullish for MORT and its constituents. The spread between mortgage rates and short-term borrowing rates will also likely increase in the coming year, which could boost the profitability of many mortgage REITs and encourage dividend growth.
The bottom line
Overall, I think it is best to avoid MORT and its components. They have risen considerably in recent months, and while some value may still remain, I don’t think their valuation rules out the risk of a liquidity crisis. Many homeowners don’t make payments and at some point this year (whether it’s April or later) their obligations will be met.
While Fannie and Freddie secure these mortgages, mREITs can still take the risk if the Fed cannot create enough liquidity to effectively bail out Fannie and Freddie once again. Since the fundamental problems in the US mortgage market are just as serious, if not worse, than they were in 2008, some lawmakers may simply prefer to let private lenders fail rather than “kick in. the box ‘once again.
This depends on whether unemployment remains higher for longer and inflation expectations continue to rise. I think we’re heading into a multi-year “stagflation” period, which would make that a significant risk. However, it is also possible that we may see a return to normal and a reversal in inflation that would save mortgage REITs. For this reason, I wouldn’t sell MORT right now, but I wouldn’t buy it either. The high dividend yield may be attractive, but DEATH could drop 50-80% + in the event of another mortgage crisis.