After many anticipated a Federal Reserve interest rate hike this year, investors have left mortgage-backed real estate investment trusts and related exchange traded funds undervalued.
Over the past year, the Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) has increased 10.5% and the iShares Mortgage Real Estate Capped ETF (NYSEArca: REM) rose 9.7%. Nevertheless, MORT and REM are both trading at a 9.2 price-to-earnings ratio and a 0.9 price-to-book.
According to Wunderlich Securities, concerns over a Fed rate hike has largely kept investors away from the space, leaving some REITs best able to hedge undervalued, reports Amey Stone for Barron’s.
“We observe that mortgage REITs typically face valuation headwinds when monetary policy becomes less accommodative, because the balance sheets of mortgage REITs are liability sensitive,” Wunderlich said in a note. “That said, hedging strategies and leverage can be managed better at some companies, and for that reason, we believe there are a few mortgage REIT stocks that are undervalued even assuming that liftoff will occur in 2015.”
The firm argues the risk to dividends is limited. Mortgage REITs offer some of the highest yields around. For instance, REM has a 12.8% 12-month yield and MORT has a 9.5% 12-month yield. [Income Investors Can Still Turn to REIT ETFs]
Additionally, there could be “pockets of value creation,” especially if the Fed delays tightening as the group remains undervalued at these levels. Specifically, Wunderlich points to potential top performers like American Capital Agency (NYSE: AGNC) and AG Mortgage Investment Trust (NYSE: MITT). AGNC makes up 13.2% of REM and 11.4% of MORT.
However, if the Fed decides to hike rates, mREITs will be pressured. Mortgage REITs rely on short-term loans, so costs could rise if short-term rates suddenly spike. However, the negative effect of higher short-term rates could be somewhat offset by quickly rising long-term rates as mREITs benefit from a steeper yield curve and arbitrage the wider spread.
iShares Mortgage Real Estate Capped ETF
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.