Finding and Managing Investment Opportunities in Residential Mortgage Loans

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The overall market for residential mortgages is immense by any standard. According to Federal Reserve Board data, the housing market in the United States represents a total value in excess of $25 trillion — and estimated debt of $10 trillion for single-family properties. The U.S. homeownership rate has varied from 63-69 percent during the past two decades, and approximately 63 percent of homeowners have a mortgage.

 

Despite the size of the residential financing market, investment opportunities involving residential real estate loans are not always obvious. Investing in this financial sector is also complicated by changes in how residential mortgages are structured and serviced. Here are four common challenges:

 

  1. The environment for servicing residential real estate loans continues to change.
  2. Contemporary residential mortgages have several complex components.
  3. Investing in securitized mortgage pools requires substantial capital and quick decisions.
  4. Active investment management is mandatory, time-consuming and ongoing.

 

 

Common Scenarios Involving Residential Property Financing Investments

 

The observations below are designed to shed some light on the major challenges faced in any effort to find and manage residential mortgage investments.

 

Regulatory and Financial Changes — One key change involves the growing lender practice of securitizing mortgages by creating marketable vehicles like residential mortgage-backed securities (RMBS). Because this removes securitized loans from the lender’s balance sheet, it also typically changes the party responsible for mortgage servicing. Another change is evolving because of servicer problems in handling foreclosures and loan modifications after the credit crisis that materialized about a decade ago. This produced stricter operational and financial controls that led to many companies selling servicing-related assets to raise capital.

 

Specialized Components of Residential Mortgages — Contemporary mortgages now include assets like RMBS, servicer advances and excess mortgage servicing rights (MSRs). Each of these components can behave differently when interest rates fluctuate. For example, excess MSR assets typically increase in value with rising interest rates. While owning MSRs and Excess MSRs provides a significant investment opportunity, the capability to own mortgage servicing rights also requires special qualifications in each state. Additional mortgage financing investment opportunities include specialized vehicles such as under-performing loans and reverse mortgage loans.

 

Steep Capital Requirements — Securitized mortgage assets frequently trade in high denominations and packaged portfolios that preclude average individual investors from participating in a practical way. An increasingly common scenario involves forced sales by institutional investors. Buying these assets requires fast decisions and turnarounds to finalize transactions and are routinely limited to pre-qualified investment groups. It is not unusual for mortgage asset investment managers to periodically act in concert with other managers to complete unusually large transactions. For example, during the past six years New Residential Investment Corp. acquired several portfolios valued in excess of a billion dollars by acting together with co-investors.

 

Mortgage Portfolios Require Ongoing and Constant Management — The dual processes of finding and managing residential mortgage assets are time-intensive and mandatory in order to produce attractive returns. The unique skill sets required include the abilities to locate undervalued mortgages, to preserve asset values in rising and declining interest rate environments and to manage assets by converting under-performing and non-performing loans to re-performing mortgages. Active asset managers must also devote ongoing attention to using appropriate interest-rate hedges and refinancing existing assets in a timely fashion.

 

 

Overcoming Challenges — Residential Mortgage Investment Specialization

 

To meet all of the challenges noted above, one practical solution is to invest in a specialized real estate investment trust (REIT) that includes an emphasis on residential real estate financing vehicles in their portfolio. Investors should ideally search for REIT candidates that have a combination of mortgage lending and servicing industry experience, adequate capital resources and specialized business relationships. A primary example of the REIT solution is New Residential Investment Corp. (trades on the New York Stock Exchange).

 

New Residential is especially well-positioned to take advantage of unique investment opportunities such as MSRs — and banks have sold mortgage servicing rights worth more than $3 trillion during the past decade. With MSRs, mortgage investment specialists can acquire new portfolio assets producing cash flow without increasing financial liabilities. New Residential is approved as a servicer for Fannie Mae and Freddie Mac and is qualified in all 50 U.S. states for mortgage servicing rights ownership.

 

 

About New Residential Investment Corp. — Public Real Estate Investment Trust

 

New Residential (NYSE: NRZ) specializes in acquiring and actively managing assets that primarily include residential real estate investments. New Residential was spun off from Newcastle Investment Corp. in 2013 and operates as a publicly traded and separate enterprise. The Company is advised and managed by Fortress Investment Group LLC, an international alternative investment manager.

 

The Company’s stock market valuation is $6.2 billion as of February 4, 2019 ($17 per share). During a 52-week period ending February 4, the trading range for the stock was $13.86 to $18.75. The annual dividend (regular cash, paid quarterly) was $2 for 2018 and $1.98 for 2017. Recent financial ratios include 7.89 for price/earnings and 100.98 for price/book value.

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