KBW: Commercial Mortgage REITs an ‘August Opportunity?’
This year’s volatility and concerns about slowing growth have increased commercial real estate uncertainty, but several factors support continued investment opportunities, reported Keefe, Bruyette & Woods, New York.
In a special report, KBW cited several issues facing the industry including elevated loan maturities, commercial mortgage-backed securities risk retention, regulatory scrutiny on banks and increased supply in certain sectors. “As a result, commercial real estate transaction volumes in 1H16 moderated while price appreciation slowed,” the report said. “These factors in combination have contributed to feelings of a later staged cycle.”
But KBW said several factors support continued investment opportunities in the sector, “including higher incremental yields, lower financing costs, a pullback from banks and CMBS and the wave of debt maturities.”
KBW also said a “lower for longer” interest rate environment and potential implications from Britain’s decision to leave the European Union could prolong the U.S. commercial real estate cycle. It estimated that commercial mortgage real estate investment trusts have underperformed equity REITs and other specialty finance peers by 7 to 18 percent year to date and by 21 to 27 percent since May 2015 and called the commercial mortgage REIT sector an “August Opportunity” during a traditionally slow trading month on Wall Street.
Commercial mortgage REITs originate and acquire CRE debt with pricing based on a credit spread over a benchmark sensitive to market dynamics including supply/demand, interest rates and relative value.
“We advocate a selective approach to CRE finance REITs with ‘Outperform’ ratings on Blackstone Mortgage Trust and Starwood Property Trust,” KBW said, citing both REITs’ “high-quality origination and asset management platforms, financing capacity and in-house special servicing capabilities.”
Several factors support continued investment opportunities in the commercial mortgage REIT sector, KBW said. First, although interest rates are low, credit spreads are wide enough to generate attractive levered returns while funding costs are low. And the $1.7 trillion pipeline of CRE debt maturities through 2020 “should provide an extended backdrop of investment opportunities,” the report said.
In addition, given the regulatory environment, banks and conduits planning to securitize through fixed-rate CMBS remain reluctant to lend on transitional assets, and recent volatility coupled with the aforementioned pullback from banks and CMBS may generate additional opportunities with higher incremental yields, KBW said.
