I'm not a fan of mortgage real estate investment trusts (mREITs), having been burned myself by dividend cuts and bankruptcies during the 2007 to 2009 recession. While I normally avoid the space, there are still a couple of names on my watch list because they don't operate the way most mREITs do. Here's a look at the two mortgage REITs an mREIT-leery investor like me might want to buy.
1. A totally different approach
Most mREITs own collections of mortgage obligations that have been pooled into securities and then use these assets as collateral for loans so they can buy more mortgages. The big risk is that the value of the pooled mortgages can fall, leading lenders to ask for more collateral. If that happens, it can set off a series of negative events, including dividend cuts, share price declines, and even bankruptcy if the REIT can't come up with the extra cash it needs.
Broadmark Realty Capital (NYSE: BRMK) doesn't operate like this. It makes short-term loans directly to construction companies. In the industry, this is known as hard money lending. Moreover, Broadmark usually only loans out about 60% of the expected sales price of an asset, so even in the face of adversity, it has some cushion.
In a worst-case scenario, the mREIT can take over a project it's funded, complete it, and sell it itself. Broadmark has basically stepped into a role banks have shied away from since the 2007 to 2009 recession. And while the coronavirus pandemic caused some issues, they were around the timing of construction, which was delayed by safety concerns, not something wrong with the basic business model.
The other big differentiator here is that Broadmark doesn't use leverage, so there's no risk of lenders calling for more capital. In fact, at the end of the fourth quarter of 2020, it had over $200 million of cash on its balance sheet it was looking to invest. In other words, there's more room for this mREIT to grow its relatively conservative business (and likely its dividend). Now add in a generous 7.9% dividend yield, paid monthly, and investors looking at more traditional mortgage REITs will probably want to take a closer look.
2. Not what you think
The next name here will probably surprise a few people, but that's not a bad thing. Hannon Armstrong Sustainable Infrastructure Capital (HASI) (NYSE: HASI) is best known as a clean energy-focused REIT, which is absolutely an accurate description.
However, if you dig into its revenues, you start to see it's more than that. Rental income only made up about 13% its revenues in 2020, while interest income was around 50%. Other financial activities (asset sales and the sale of receivables) and fees rounded out the top line. All in, Hannon Armstrong is more mortgage REIT than anything else.
Now, to be fair, Hannon Armstrong is expensive today, noting its 2.4% yield is near historic lows. Value-conscious types will not be interested, but they may still want to keep this REIT on their watch list for a pullback. That's because it's providing capital to the fast-growing clean energy industry.
Yes, the current zeitgeist has the stock price at an elevated level, but there's a reason for that, given the global push toward low-carbon energy options like solar and wind -- both of which are core to Hannon Armstrong's portfolio. Moreover, the REIT currently has a roughly $3 billion pipeline of projects ahead in which it expects to participate, continuing the growth of its portfolio.
So, despite the low yield, investors looking at the clean energy space might want to dig in here. At the very least, Hannon Armstrong deserves to be on your watch list, even if you're a value investor. It's a unique way to play a market trend that doesn't involve the same level of risk as a company that's physically building renewable power assets.
If you're looking at mortgage REITs, the first thing I would say is to be cautious of names that use pools of mortgages to back loans so they can buy more pools of mortgages. There's more risk there than many people realize.
That said, every mortgage REIT isn't the same, with some, like Broadmark and Hannon Armstrong, using the mREIT approach to do something different. In fact, if you take the time to get to know these two, you might find you like what they're doing enough to add one or both to your portfolio today.