Must-know: Why increasing home prices are important for REITs



The de-leveraging of the consumer is driven in part by home price appreciation

The biggest economic challenge of the recovery has been the indebted consumer. Consumption has fallen as consumers have focused on repaying debt. Negative equity has prevented the jobless from leaving areas with limited job prospects and moving to areas with more promise.

The theme of the real estate market for the past year has been tight inventory. Professional investors (think hedge funds and private equity firms) have raised capital to purchase single-family homes and rent them. This has been driven by auctions from the federal government, primarily the FDIC and FHA. These entities have been auctioning off billions of dollars worth of real estate and required investors to hold them for a period of three years. This has taken supply off the market (or at least the perception of supply), which has helped the real estate market find some support. These professional investors are competing for properties with first-time homebuyers, which is making the starter home a scarce commodity.

Implications for mortgage REITs

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Real estate prices are big drivers of non-agency REITs, such as Two Harbors (TWO), PennyMac (PMT), or Redwood Trust (RWT). When prices are rising, delinquencies drop, which helps servicers and those who invest in non-agency (non government-guaranteed) mortgage-backed securities. It also helps reduce stress on the financial system, which makes securitization easier and lowers the cost of borrowing. Finally, those REITs with large legacy portfolios of securities from the bubble years are able to stop taking mark-to market write-downs and may revalue their securities upwards. Since REITs must pay out most of their earnings as dividends, higher earnings means higher cash flows to the investor. While agency REITs, like Annaly (NLY) or American Capital (AGNC), don’t bear credit risk, they’re affected by rising home prices, as they increase prepayment speeds.


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