It has been another tough stretch for income investors in the challenging hunt for yield. But even in challenging times, there are pockets of the market where investors can earn a steady income stream.
Mortgage real estate investment trusts are one such area, as the sector offers near double-digit yields and, in some cases, the opportunity for meaningful price appreciation. This comes after the sector got a scare at the beginning of the pandemic, thanks to a series of margin calls owing to mostly short-term financing that was marked to market at depressed prices during the initial rout. Since then, many have shifted away from mark-to-market funding.
“They’ve taken a more prudent approach to funding, and in a low-rate environment, they’re able to fund their balance sheets really well,” David Schawel, chief investment officer at Family Management Corp., told Barron’s.
The opportunity in mortgage REITs comes as the yield on the 10-year Treasury note hovered around 1.25% this past week, despite evidence that the Federal Reserve may begin to slow its bond buying this year. Rather than focusing on signs that the Fed will pull back on its easy-money policy, investors have been paying more attention to recent economic data, which showed worsening consumer sentiment and weaker-than-expected retail sales figures for July.
But despite the hiccup last year, REITs that own mortgage debt have proved a reliable source of yield for investors in the later phases of the pandemic. Many offer yields approaching 10%.
MFA Financial (ticker: MFA) is one that has recently been favored by Wall Street. The New York–based REIT has lowered its cost of funding through securitizations, recognizing a 15% quarter-over-quarter drop in interest expense from the most recent quarter. Roughly two-thirds of its asset-based financing is nonmark-to-market, with the bulk of that portion coming from securitizations. MFA plans to complete two additional securitizations in the third quarter.
The REIT currently yields 8.8% and trades at roughly 0.8 times its book value, according to FactSet data, just below its five-year average of 0.9 times and lagging behind peers. The high yield, coupled with what analysts believe is a steeper-than-deserved discount, makes for a compelling return opportunity.
“With MFA, you’re getting [nearly] 9%—which is low for the REIT—but you’re buying below book value when MFA has an opportunity to raise the dividend,” Eric Hagen, director of research at BTIG, tells Barron’s. Shares recently traded at $4.45 apiece, but analysts expect that shares could hit $4.80, implying nearly 8% upside.
Income Investing
Redwood Trust (RWT) is another mortgage REIT favored by analysts, and is a “top idea” at Keefe, Bruyette & Woods. At first glance, it might not be as compelling as MFA, given that Redwood yields 5.9% and already trades at book value. But KBW has been interested in Redwood’s business evolution, primarily its acquisition of CoreVest. The acquisition gave Redwood more of a foothold in the business-purpose lending market, which offers bridge loans for fix-and-flip investors and single-family rental loans—areas that can help Redwood earn 10% to 12% on its investment portfolio.
“We expect strong mortgage banking activity, recovering asset prices, and increased call activity to enable [Redwood Trust] to generate solid ROE and grow book value (and potentially the dividend),” wrote Bose George, analyst at KBW, in a note last month. Analysts surveyed by FactSet expect shares to hit $14 apiece, up 17% from recent trading levels.
While it may be challenging to find yield as a matter of course in today’s markets, income-hungry investors may not need to search further than home.
Write to Carleton English at [email protected]
