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Why state laws matter to nonagency REITs


Aug. 18 2020, Updated 6:23 a.m. ET

State foreclosure affects foreclosure inventory

There are basically two types of state foreclosure laws: judicial and nonjudicial. In nonjudicial states, foreclosures are handled through a streamlined process and generally take a few months. In judicial states, foreclosures can take years, as judges are often reluctant to push delinquent borrowers out of their homes.

As you can see from the map below, the states with the largest foreclosure inventory (New York, New Jersey, and Florida) are the states with judicial foreclosure processes.

Foreclosure inventory affects home price appreciation

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We’ve seen that home price appreciation varies widely by location. In California, the foreclosure pipeline has been worked through, and we’re seeing price appreciation and bidding wars reminiscent of the peak of the bubble years. In the judicial states (particularly New York, New Jersey, and Connecticut), we’re seeing much lower home price appreciation. In fact, there’s very little residential construction, at least compared to some of the other states.

New York State has started to examine the issue of zombie homes—homes no longer occupied by borrowers, but the responsibility hasn’t transferred to the bank. These homes become decrepit and can affect the value of real estate in the neighborhood. Streamlining the foreclosure process for nonowner-occupied homes in New York would go a long way toward fixing this issue.

Implications for mortgage REITs

Real estate prices are a bigger driver of nonagency real estate investment trusts (or REITs) such as CYS Investments (CYS), Newcastle Investment Corp. (NCT), and Redwood Trust (RWT) than they are of agency REITs such as Annaly Capital Management (NLY) and American Capital Agency (AGNC). When prices rise, delinquencies drop. This is important because nonagency REITs face credit risk. Even for agency REITs, which invest in government mortgages, rising real estate prices can drive prepayments, which negatively affects their returns.

Rising real estate prices also help reduce stress on the financial system. This 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 mean higher cash flows to the investor.


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