You can't think of everything, but sometimes when you finally do find the answer, you feel stupid for not having thought of it earlier. That certainly applies right now to my understanding of long term Mortgage REIT performance. Of course, not being able to think of everything is exactly what the nature of this business is about, so I'm not too discouraged.
Last week I posted my analysis of the MREIT business. Everything I said there is still good, but if I had found this MREIT index sooner then I would have invested less in MREITs, or perhaps invested nothing.
MarketVector's US Mortgage REITs Index
I remember many years ago standing in a book shop in Santa Monica on Wilshire Boulevard reading a book about stock investing. It mentioned the Ibbotson and Sinquefield paper "Stocks, Bonds, Bills, and Inflation: Year-by-Year Historical Returns (1926-1974)", and it greatly impressed me that the returns were so high even though they encompassed the Great Depression and the time period started in the middle of the Roaring 20s. Having this big picture view of the market immediately put a foundation under the idea that stock investing could be not just lucrative, but inevitably so, regardless of short term fluctuations. You are reading part of the fruit resulting from that information.
With this background, you might think that each time I approach a new investment class that I might seek out data on the long term performance of the group as a whole. I will now. I did not do so with MREITs until earlier this week when, on a whim, I wondered if anyone compiled an index or benchmark on the MREITs. Of course they exist, and though there may be others, I'll focus briefly on the MarketVector MVMORT index here.
The index contains 26 U.S. mortgage-based REITs. The usual suspects are here: NLY, STWD, AGNC, BXMT, RITM (formerly NRZ), ABR, TWO, CIM, PMT. You can see from the components page that these are indeed the MREITs we are looking for.
Obviously, there are at least two components to equity return, capital appreciation and dividends. MREITs tend to have poor capital appreciation but excellent dividends. The dividends are, in fact, too good to be true, as is reflected by the terrible performance of MREITs in capital appreciation, as we can see from the Price performance shown in the MVMORT index, which as of 8/26/22 was -80.97% since the inception of the index on 12/30/2004. If you add in dividends, then gross return rises to 77.11%, but remember this is a total return across 17.66 years. Annualized you got 3.29%. The net return (after taxes or withholding, I presume) was -11.91% or -0.72% annualized.
From the graphs of the indices it's clear that although the 2007-2009 mortgage crisis was a drag on MBS and MREIT returns, the 2020 COVID shock was much worse. You might be charitable and decide that these two events were extraordinary and therefore the index is not representative of the prospects of MREITs. Nevertheless, the index covers 18 years of time, a significant sampling, even if not as compelling as the SBBI period of 1926-1974.
I am not as inclined to be charitable, and see MVMORT as a fair representation of the prospects of the MREIT sector, which I think was fairly characterized by the analysis I posted here on August 16th. More informally, I think of the U.S. mortgage as a strange and amazing artifact that tends to benefit the borrower most. It is at a low interest rate, tax deductible, and allows you to make a highly leveraged investment on a practical and useful capital asset that enjoys special legal protections. The U.S. mortgage is so good a device (for the borrower) that it leads to, and has often led to, overinvestment in homebuilding, leading to excessive real estate prices, homes that are too large, and stranding of capital. By providing special tax advantages for mortgages, the U.S. Government has increased the volatility of the housing sector, which in turn has increased the frequency and severity of financial crises based on mortgages. In that sense, U.S. tax policy caused the 2008 financial crisis.
One might think of MREITs as specialized trading vehicles, to be used like equity options, index options, leveraged or short index closed end funds. If you treat it as toxic waste with zero-sum characteristics, in which staying too long with an MREIT is an indicator of mental illness, then you might have the right approach to dealing with MREITs. Keep in mind, though, that the same quants (or AI-based SAIMS traders) who have mastered MBS will also have the inside track on MREITs.
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