Did the Fed Just Initiate the Next Bullish Cycle for Mortgage REITs?

Investing.com – The Federal Reserve’s recent decision to reduce interest rates by 50 basis points could signal the beginning of a bullish phase for mortgage REITs (mREITs), according to a report from B. Riley.

The firm observes that historically, Fed rate-cutting cycles have aligned with improved performance in mortgage-related stocks, as mREITs, which are highly responsive to interest rate fluctuations, benefit from lowered funding costs and enhanced earnings potential.

B. Riley highlights that mREITs predominantly utilize short-term debt financing, typically maturing within 30 to 90 days. As interest rates fall, these entities can refinance at lower rates, which “enhances the carry on long-duration MBS holdings” and increases earnings capacity.

The report also indicates that lower rates enable management to operate with greater leverage and widen duration gaps, further boosting profitability.

The firm expresses that current valuations of most mortgage stocks do not adequately reflect the anticipated improvement in fundamentals. It notes that residential mREITs are trading near 0.9 times book value, offering a 13% forward dividend yield.

Agency mREITs are expected to experience the most significant advantages from the Fed’s rate cuts, largely due to their dependence on fixed-rate mortgage-backed securities and short-term financing.

Additionally, hybrid and non-agency mREITs are projected to benefit from better securitization economics and increased mortgage origination volumes.

On the commercial side, mREITs are anticipated to gain from improved cap rates and higher transaction volumes, even with some modest spread compression.

B. Riley concludes that as the Federal Reserve appears poised to continue cutting rates, mREITs are well-positioned for a prolonged bullish trend.