The sector of real estate investment trusts that specialize in the secondary mortgage market will post returns on equity averaging in the mid-teens for the fourth quarter, a Credit Suisse analyst predicted in research released this week.
Douglas Harter wrote two factors will keep ROE higher in the first half of 2011 — a recent spread widening between current coupon mortgage-backed securities and mortgage REIT cost of funds (derived from a combination of LIBOR-based and three-year interest rate swaps) and the sector’s latest round of capital raising activity.
“The sustainability of ROEs is dependent on the timing of increases in short-term interest rates,” he wrote. “[O]ur estimates assume rates begin to rise in early 2012.”
The analyst added the greater sustainability of returns will come from hybrid/non-agency mortgage REITs because that interest rate risk is mitigated. In addition, he wrote that residential mortgage REITs are relatively fairly valued and he expects dividend yields to remain attractive.
“We favor the mortgage REITs that are generating the highest returns on equity and expected dividend yields for investors,” he wrote. “Within residential mortgage REITs, we favor the hybrid model as we see the yields as being more sustainable.”
