A real estate investment trust (REIT) finances, operates or owns real property and mortgages in a number of different sectors. Because many REITs are publicly traded, owning shares allows investors to add real estate to their stock portfolios. According to Nareit, a worldwide organization of real estate investment trusts, REITs now control more than $3 trillion of real estate assets.
REIT “types” are often determined by the primary category of assets — five key examples are mortgages, office buildings, healthcare facilities, retail properties and residential real estate. While real estate investors can always choose to buy individual properties instead of REIT shares, historical REIT returns make this a decision requiring closer examination. As reported by Marc Prosser (Forbes, July 19, 2017, “Data Proves REITs Are Better Than Buying Real Estate”), REITs “have historically outperformed direct real estate investing and even the S&P 500.”
Residential Real Estate Mortgage REIT Choices
Two more important questions for real estate investors are the following:
- Investing in mortgages or properties?
- Invest in residential or commercial real estate?
One of the most specialized REIT investment opportunities features the combination of mortgages and residential properties. The residential real estate loan market has increased in both size and complexity during the past 20 years. As reported by the Federal Reserve System’s Board of Governors, the U.S. housing market represents about $25 trillion in estimated value — and approximately $10 trillion in single-family mortgage debt. Due to a credit crisis that peaked about a decade ago, the residential real estate lending industry has undergone significant changes in how mortgages are serviced and owned.
While finding desirable investment opportunities in residential mortgage loans might seem overwhelming for individual investors, the challenge becomes much more manageable by employing the structure of a management and advisory team within a specialized real estate investment trust. For example, new and complex financial concepts such as servicer advances, excess mortgage servicing rights and mortgage securitization are now commonplace. One primary example of an REIT that was created to find undervalued residential real estate loans and other special investment opportunities is New Residential Investment Corp.
REIT Specialization: MSRs, RMBS, Call Rights and Servicer Advances
As noted above, a property-oriented real estate investor can buy properties directly instead of buying REIT shares. However, for a mortgage-oriented investor, an REIT investment will typically be more practical and cost-effective.
One reason is the scale involved — securitized residential mortgages typically are sold only to pre-qualified buyers capable of investing millions (and often billions) of dollars on short notice. Another potential obstacle that precludes most individual investors from successfully securing and then managing undervalued residential mortgage loans is the time factor — the process of finding, buying and actively managing a loan portfolio is time-consuming and frequently requires a lengthy time frame until assets are sold.
To illustrate how specialized and complex it can be to invest in residential real estate financing vehicles, here are four of the key asset classes frequently included in the New Residential Investment Corp. portfolio:
- Excess MSRs (Mortgage Servicing Rights)
- RMBS (Residential Mortgage-Backed Securities)
- Call Rights
- Servicer Advances
An MSR is the right to service a mortgage loan pool (usually acquired in exchange for a fee). By most measures, banks currently own more than 70 percent of MSRs. This percentage is expected to decline in future years as banks find it necessary to improve capital reserve requirements, comply with regulatory changes and overcome new servicing challenges. By co-investing in MSRs, New Residential can acquire an “Excess MSR” (compensation that exceeds the normal fee for servicing) — this results in regular cash flow without accompanying liabilities or obligations.
RMBS are created when residential real estate loan pools are securitized (converted into marketable securities). It is estimated that about 70 percent of residential mortgages are securitized. Institutional investors are periodically forced to sell some of these assets at inopportune times. Especially for non-Agency RMBS situations, such forced sales often result in buying opportunities at attractive prices.
Call rights give the buyer a right (without the contractual obligation to do so) to buy a mortgage securitization vehicle at a specified price within a designated time period. Making this a profitable transaction typically requires a judicious combination of selectively retaining mortgages, selling performing loans for a profit, re-securitizing assets and acquiring designated tranches (specific underlying pieces of the debt) at a discount to par values.
A servicer advance is common in securitization processes. Such advances are usually provided as non-interest bearing loans from a servicer to cover circumstances that include missed homeowner payments until a loan is re-performing. The advances improve liquidity, are considered to represent a high credit quality and enhance cash flow and yields.
About New Residential Investment Corp. — Specialized Residential Real Estate Assets
New Residential is publicly traded on the New York Stock Exchange (ticker symbol “NRZ”) and operates as a qualified REIT. Michael Nierenberg is President, CEO and Board Chairman of New Residential. The company is based in New York and focuses on opportunistic residential real estate investments such as excess mortgage servicing rights and servicer advances.