KBRA: More mortgage REITs eyeing CRE lending

More residential mortgage REITs are seeking to diversify into commercial real estate lending as they struggle to hit target dividends, according to a report from Kroll Bond Rating Agency.

More residential mortgage REITs are seeking to diversify into commercial real estate lending as they find it increasingly difficult to maintain target dividends, according to a new report from Kroll Bond Rating Agency.

While much of the growth in the sector was traditionally due to purchases and originations of agency and non-agency residential mortgage-backed securities, the report pointed to “signs that some traditional agency mortgage REITs are diversifying towards commercial real estate securities.”

Margin compression, rising interest rates and pressure to meet target dividends has compelled the REITs to either diversify or lever up, but leverage covenants put into place after the recession hold the REITs to only moderate levels of leverage: debt-to-equity ratios of 3 to 5 times for non-agency portfolios and 6 to 8 times for agency portfolios, according to the report.

The dividend yield of the FTSE NAREIT Mortgage REITs Index was 11.25% as of June 30, 2015, outpacing the dividend yield of the S&P 500 of about 2%, but the REITs are keen to diversify in order to meet target dividends as the additional market pressures mount, experts said.

“The current environment of margin compression, with high-yielding bonds being replaced with lower-yielding securities, while the cost of funding remains unchanged, is forcing residential mREITs to look for alternatives in order to maintain target dividends” the report stated.

In one recent example, New York-based Annaly Capital Management — which had focused on agency residential mortgage lending for over two decades — in May hired a team from GE Capital Real Estate to expand its commercial real estate originations business.

The strategy shift accompanies a massive wave of 10-year CMBS maturities come up for refinance: an estimated $300bn worth of loans will mature in the next three years, according to data and research firm Trepp.