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  1. Home
  2. / Investing
  3. / Real Estate

Mortgage REIT Activity Bodes Well for Housing

I'm revving up those income vehicles this week.
By ROGER ARNOLD May 24, 2016 | 04:00 PM EDT
Stocks quotes in this article: TOL, REM, ARCC, ACAS, PSEC

I've received more inquiries concerning income vehicles in the past month than since the taper tantrum of 2013, so I'm going to dedicate this week's columns to the subject.

The interest is clearly driven by concerns about the impact on the principal value of income investments caused by Fed rate hikes and the potential for higher long-end Treasury yields and interest rates as a result.

The sector I've focused my attention on since the 2013 taper tantrum, with respect to income, has been the mortgage real estate investment trusts (REITs).

Today's data and performance of the REITs is instructive as to the near-term potential for them.

The spectacular surge in new home sales in April, as reported by the Census Bureau this morning and supported by the Toll Brothers (TOL) earnings report, has sent the homebuilder stocks soaring, and has helped to push the yield on the 10-year U.S. Treasury to its highest level in a month as expectations of a Fed rate hike in June increase along with the prospects for a recovering economy driven by consumption.

The primary concern mortgage REIT investors have had is the potential for this activity to have a negative impact on REIT prices.

However, there's been little response by them to the data this morning and the iShares Mortgage Real Estate Capped ETF (REM), which owns most of the individual REITs I've written about previously, is actually trading up slightly on the day.

The potential for this activity is part of what I wrote about in the May 11 column, "I Still Say I'm Right on REITs."

The action in the mortgage REITs today is evidence that positive expectations for housing activity are taking precedence to the potential negative implications of higher mortgage rates.

It also implies that the legacy issues remaining from the last housing and mortgage busts have largely been resolved and no longer present a material risk to the existing mortgages held by the REITs.

This is a big event for REIT investors and those who've been watching them for signs of another crash in their prices, as occurred in 2013 when mortgage long-end Treasury yields and mortgage rates rose at the fastest rate in history.

One of the reasons for the lack of a negative reaction by the REITs to today's data is that they never recovered from the crash in prices in 2013. That's also left them with incredibly high dividend yields, all of them over 10%.

The action today will begin to be considered as validation by potential REIT investors who've been on the sidelines that a bottom, or very near to it, has already been put in for them.

This should prove to be the catalyst for those investors to begin to move back into the REITs again.

This is a double-edged sword for existing REIT investors, though.

As new money begins to move back into the REITs, it will be coming from investors with a low threshold for principal volatility.

These are the same investors who sold en masse in 2013. That also means that as they move back in the REIT prices will increase, but it also raises the probability of them reversing course and selling at the first sign of concerns that long-end Treasury yields and mortgage rates may increase similar to the 2013 rate.

I don't think that will occur, but existing mortgage REIT investors should expect that price volatility will increase from here.

They should also not worry about it or take any action because of it.

It should be monitored, though.

My principal concern at this juncture is a flight into the REITs that causes the prices to rise and yields to decline dramatically. If that occurs, I will likely advise selling the REITs and considering other income vehicles.

I don't expect that to be an issue in the near future, but will be writing about other income vehicles this week.

As per a request by Real Money subscriber krk_krk in the comments section of last week's column, "Planets Are Aligning for a Rate Hike," I'm going to write about the high-yielding business development companies and that sector in tomorrow's column.

If you want to get a head start on that subject, the three companies I'll address initially are Ares Capital (ARCC), American Capital (ACAS) and Prospect Capital (PSEC).

As is the case with the REITs, I advise following the commentary from Real Money columnist Tim Melvin on this sector, too.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Arnold had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Real Estate

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