Credit Suisse: Updates Mortgage REIT Sector - Top 3 mREIT Picks

On April 1, Credit Suisse published a comprehensive note on the mREIT sector, "Book Value Improved From January Lows; 10.8% Discount to Book Attractive." As the title suggests, CS believes that the risk/return on mREITs has improved, making the sector's 12 percent average yield more appealing for income investors. CS - Book Value Estimates

That said, Credit Suisse also noted the "challenging operating environment," which makes them inclined to favor "mortgage REITs, which are building out operating businesses and can create their own investments." CS - 3 Top Picks  PennyMac Mortgage Investment Trust

$1.6 billion market cap.  Starwood Property Trust, Inc.

$5.4 billion market cap.  Two Harbors Investment Corp.

$3.9 billion market cap.

While PennyMac's dividend yield has been the highest during the past 12 months, PMT's total return has lagged significantly behind Starwood and Two Harbors. CS - 5 Year Risk-Adjusted Returns However, when Credit Suisse took a longer view on risk adjusted performance PennyMac has notably been a top performer, returning 205 percent over the past five years, as can be seen clearly on Exhibit 11, below.

Notably, Starwood Property Trust performance was not included for comparison although it has been publicly listed since August 2009. CS - PennyMac: Overweight, $24 Target Price  PMT shares closed on April 1, at $21.40 per share.  CS new EPS estimates for 2015 - 2017 are $2.60, $2.58 and $2.50, respectively. CS - Starwood: Overweight, $26 Target Price  STWD shares closed on April 1, at $24.26 per share.  CS new EPS estimates for 2015 - 2017 are $2.15, $2.25 and $2.35, respectively. CS - Two Harbors: Overweight, $11.50 Target Price  TWO shares closed on April 1, at $10.64 per share.  CS new EPS estimates for 2015 - 2017 are $1.02, $1.06 and $1.10, respectively. The consensus estimates and old Credit Suisse estimates can be reviewed in the table below as a basis for comparison. Credit Suisse - Updates mREIT Sector EPS

Investor Takeaway While most investors are familiar with equity REITs which own: office, retail, industrial and other commercial real estate asset classes -- mREITs are an entirely different animal. Mortgage REIT strategies can vary widely, and while most mREITs benefit from interest rate decreases, others would actually benefit from rate increases. Asset classes, hedging strategies and leverage can vary widely from company to company. It is crucial for a beginning investor to understand that a high mREIT dividend, can actually become a "sucker yield," if the book value of its assets declines, and/or the dividend is cut, resulting in a disappointing total return.