Steven Delaney, director of specialty finance research and senior analyst with JMP Securities, tracks the residential and commercial mortgage sector for the firm. The award-winning analyst was previously director of research with Flagstone Securities and has also served in senior financial executive roles.
What is your 2019 outlook for mREITs?
It’s a mixed outlook because there are two very distinct business models. The themes we watch across all the models are the interest rate environment and the credit environment. The credit environment is heavily tied to the economy and real estate fundamentals, both residential and commercial.
Agency REITs primarily invest in Freddie Mac and Fannie Mae mortgage securities, and they strive to manage the interest rate risk. Commercial mREITs primarily make direct commercial real estate loans, the vast majority of which are floating rate loans.
We are generally cautious on the agency REITs, and we are broadly positive about the commercial mREITs.
What makes you so positive about commercial mREITs?
The primary reason is that they invest largely in senior first mortgages and commercial mortgage-backed securities. And those senior first mortgages are mostly floating-rate loans indexed to one-month LIBOR. So their returns directly benefit from the Federal Reserve’s raising of short-term interest rates.
We think the next two to three years are very likely to be a better environment to be a lender on real estate than to be an owner of real estate. It’s the Fed hiking and the flattening of the interest rate yield curve that cause us to be cautious on agency REITs.
What’s your outlook for interest rates next year?
When the Fed considers raising rates, I don’t think their terminal federal funds rate will exceed 3 percent. The question is, for the Fed to go to 3 percent they have to hope that the economy will continue to grow, inflation will pick up, and the 10-year yield will move to 3.5 to 4 percent.
It will be a game of chicken when we get into the second half of next year. I think it is possible that the Fed will get to the 2.5 percent range, and then they will slow down, skip some meetings, and take a pause and wait and see how things play out.
Do you see any spillover risks from the global economy to the U.S economy and mREITs?
The trade talks are ugly and noisy, and they create short-term problems. But it’s in no country’s interest for them to continue long term, and they will be resolved. I don’t see any material risks of any change in the global economy impacting mREITs over the next couple of years.
How could any potential reform to Fannie and Freddie impact the agency REITs?
I don’t feel that Freddie and Fannie today represent an existential risk to the U.S taxpayer. We need FHA to make the loans that the private sector doesn’t want to get involved with.
We also need an agency that represents a public-private partnership, which is what Freddie and Fannie represent, especially in their multifamily programs.
I don’t think the effect (of reform) will be negative to agency mREITs because they will always have agency MBS to invest in. There may just be a different name on the bond.