Investing.com — The Federal Reserve’s recent decision to cut interest rates by 50 basis points may have sparked the next bullish cycle for mortgage REITs (mREITs), according to a new report from B. Riley.
The company notes that Fed rate cut cycles have historically coincided with rising performance of mortgage-related stocks because mREITs, which are highly sensitive to interest rate changes, benefit from lower borrowing costs and improved earnings potential.
B. Riley emphasizes that mREITs rely heavily on short-term debt financing, which typically matures within 30 to 90 days.
As interest rates decline, B. Riley explains that mREITs can refinance at lower rates, which “increases the carry-on of long-term MBS ownership” and increases earnings power.
The note also highlights how lower interest rates allow management to operate with higher leverage and widen maturity spreads, further improving profitability.
“We believe that most mortgage stocks today are not reflecting the expected improvement in fundamentals,” said B. Riley, noting that residential mREITs are currently trading at almost 0.9x book value with a forward dividend yield of 13%.
Agency mREITs, such as ARMOR Residential REIT (NYSE:) and Cherry Hill Mortgage (NYSE:) Investment, are expected to see the biggest benefit from the Fed’s rate cuts due to their reliance on fixed-rate mortgage-backed securities (MBS) and financing on short term.
Hybrid and non-agency mREITs, including Ellington Financial (NYSE:) and Mortgage New York (NASDAQ:) The trust is also expected to benefit from improved securitization economics and higher mortgage production volumes.
Meanwhile, commercial mREITs, such as Franklin BSP Realty Trust, are expected to benefit from improved cap rates and higher transaction volumes, despite modest spread compression.
B. Riley concludes that with the Fed likely to continue cutting rates, mREITs are well positioned for a continued bullish cycle.
