Harsh Hemnani, senior debt research analyst at Green Street, joined the REIT Report podcast to review current trends across the commercial and residential mortgage REIT (mREIT) sector.
Hemnani discussed the size and breakdown of the mREIT market, the current operating environment, macroeconomic forces impacting performance, valuation and total returns for MREITs, risk profiles, and the outlook for the sector over the next 12 to 24 months.
Commercial mREITs are able to underwrite idiosyncratic, property-level risk, Hemnani said. Not only can they execute the loan quicker than other lenders, but they also provide certainty as to who the loan counterparty will be throughout the life of the loan. “mREITs take out that uncertainty and that’s the value proposition they provide to the commercial real estate market,” he noted.
Hemnani described the backdrop for commercial mREITs today as encouraging. “If you think about commercial real estate credit, it's fairly attractive on a risk adjusted basis. Property values have declined roughly 20% from their peak and they seem to have stabilized. So the risk of a broad-based property value decline from there is fairly low.”
He added that expected returns or spreads on new loans are roughly in line with their long-term average, “which sets up a very attractive risk adjusted return backdrop.” From a liquidity perspective, commercial mREITs are “in a much better spot today than we were a year ago…we're moving in the right direction.”
On the residential mREIT side, “we're almost firing on all cylinders,” Hemnani said. Residential mREITs have a good cost of capital on the equity side, he said, “so getting liquidity from the equity market by raising more shares is a good option for them and is accretive to their needs.”
Looking ahead, “for commercial mREITs, the biggest opportunity is capitalizing on the attractive risk adjusted returns available in commercial real estate loans today. So, resolving their assets that are not fully performing and reinvesting those proceeds into new loans that are much healthier from a credit perspective,” Hemnani said. For residential mREITs, “convexity still offers a healthier return versus credit and duration, so mortgages in that environment are still an attractive asset to have as a fixed income investor,” he added.