REITs struggle to gain foothold in mortgage finance
At the start of 2011 real estate investment trusts were all the rage. Eight months in, and that picture has changed dramatically. The market now must deal with new players who use tax-exempt REIT status for new types of hedging. And short-term success may rest ultimately on upcoming regulatory decisions at the Securities & Exchange Commission. Speakers at a REIT panel during the Information Management Network ABS East 2011 conference in Miami say that it’s unlikely the vehicles can really play a significant financing role in addressing the shortage in mortgage financing. "The beginning of the year kicked off with people looking for returns and the market was bullish and thought that the mortgage market was a natural market for REITs – this was a way out," said Dan Nigro, an investor with ABS Credit, speaking at the panel. "In the last half of the year the prices on securities have gone down, which has been reflected in some non agency residential mortgage pricing. It’s amazing how much market conditions have changed." The pricing of these securities has made it difficult for REITs to attract product. "Agency-only mortgage REITs (those investing in Fannie Mae and Freddie Mac) have also been hot by a flattened curve," said Terence Meyers, director at Deloitte Tax, speaking at the panel. "In the past to generate some level of return these vehicles would have to increase leverage 7 to 8 times debt to equity; today it would require leverage in excess to that." The uncertainty as to when the private securitization market will open makes it hard for REITs to raise capital. The panelists said that existing REITs have maintained an advantage over new IPOs because establishing a new REIT can sometimes take three to four months. In the meantime existing vehicles could issue in overnight market without having to wait for registration with the SEC. But that hasn't happened, as "incumbent" REITs continue to saturate the market with multiple issuances, which didn’t allow new vehicles to access the market, said Meyers. Also brewing in the background is a potential new regulatory change that could threaten the exemption from registration for mortgage REITs. The SEC concept release, published Aug. 31, explicitly said that companies engaged in the mortgage banking business were excluded from regulation under the Investment Company Act of 1940 because they were not considered to be issuers in the investment company business. The SEC is concerned that current guidance is insufficient for companies to judge correctly their status under the 1940 act, and that SEC staff no-action letters over the years may have led firms to interpret the exclusion beyond its intended scope. Effectively mortgage REITs are allowed to achieve a higher level of debt leverage ratio than if they were a registered company. The panelists said that public comment on the SEC concept release is due at the beginning of November and it's uncertain what direction the regulator will take. "There is a view that the SEC will be more open to allow exemption because of the method of transmission it chose to review the issue," said Meyers. "One option could have been to issue a rulemaking process, they haven’t done it and I think that means they are going to listen to the industry." Otherwise if the SEC takes the opposite tack and reduces the amount of allowable leverage, it would reduce the amount of capital REITs can invest in the market, explained Meyers. Why the SEC has chosen to make its move now was also discussed and panelists said it’s likely that the increased interest in this segment of the market may have prompted the regulator to do so. "Perhaps the SEC is concerned over the new phenomenon created by two in twenty new REITs that have shown up like the PIMCO REIT," said Nigro. "It’s essentially a hedge fund in mortgage related assets and it looks significantly different than IPOs of past. Perhaps more of these REITS were being sold to retail investors and the SEC has stepped in to say that there are limits to what this market can do." Meyers echoed this sentiment and said that with the number of new vehicles that have popped up in the last year the SEC wanted to provide clarity with what it was willing to accept and to provide the market with limits. Meyers said that while regulatory uncertainty is a concern, the larger macroeconomic factors have had more of an impact on the REIT space. "The concerns around the flattening curve and increasing number of prepayment are more impactful," he said.