The 3 Best-Performing Mortgage REITs Over The Past Year

One of the lesser-known and misunderstood real estate investment trust (REIT) subsectors is mortgage REITs (mREITs). While investors can grasp the concept of REITs that own and manage tangible properties such as office buildings, apartments or strip malls, it's a bit more difficult to visualize exactly what mREITs do.

Most mREITs invest in mortgages and mortgage-backed securities (MBS) that generate income from interest is paid from those securities. An MBS is a bundle of home loans and various types of real estate debt that are purchased from the banks that originate them. MBS investors receive periodic interest payments, similar to bond coupon payments. If you drive through a residential neighborhood, many of the homes that you pass might have mREITs holding the loans.

While investors are more familiar with the larger market cap mREITs, such as Annaly Capital Management Inc. NLY, AGNC Investment Corp. AGNC and Starwood Property Trust Inc. STWD, despite very high dividend yields, all three have had negative one-year total returns in this rising interest rate environment.

But take a look at three smaller cap mREITs that have demonstrated positive total returns and outperformed other mREIT peers over the past year.

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Seven Hills Realty Trust SEVN is a Newton, Massachusetts-based mortgage REIT since 2008 that originates and invests in first mortgages secured by middle-market and transitional commercial real estate. It's externally managed by Tremont Realty Capital, a subsidiary of the RMR Group Inc. RMR.

On July 18, Seven Hills Realty announced it closed a $26.5 million bridge loan to finance the acquisition of Woodfield Commerce Center, a 320,000-square-foot industrial warehouse property in Fountain Inn, South Carolina. The two-year initial term loan has a possible one-year extension option.

On July 31, after the closing bell, Seven Hills Realty Trust reported its second-quarter operating results. Earnings per share (EPS) of $0.37 beat the estimates of $0.34 by 8.82% and was a 54.17% increase over EPS of $0.24 per share in the second quarter of 2022. Revenue of $9.09 million beat the estimates for $8.76 million and was a 21.23% increase over revenue of $7.5 million in the second quarter of 2022.

Seven Hills Realty Trust has been the best-performing mREIT with a total one-year return of 12.09%. It pays a quarterly dividend of $0.35 and the annual dividend of $1.40 yields 13.25%.

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Seven Hills Realty has increased its year-over-year EPS growth over the last three quarters. One caveat to note — Seven Hills Realty's payout ratio is almost 100% of its annual earnings per share, so it will have to continue the EPS growth in order to provide better dividend coverage and safety.

Arbor Realty Trust Inc. ABR is a Long Island, New York-based mortgage REIT that initiates bridge and mezzanine loans for commercial and residential properties. Many of its loans originate through Fannie Mae and Freddie Mac programs.

Arbor Realty Trust generates profits by the spread between the cost of financing a loan and the interest earned from that loan. Many of Arbor Realty Trust's commercial loans are first mortgage liens that are short term with higher interest rates.

After the closing bell on July 28, Arbor Realty Trust reported its second-quarter earnings. EPS of $0.57 beat the estimates of $0.44 by 29.55% and was a 9.62% increase over EPS of $0.52 per share in the second quarter of 2022. Revenue of $108.54 million beat the estimates for $99.11 million and was a 15.15% increase over revenue of $94.28 million in the second quarter of 2022.

In addition, Arbor Realty raised its quarterly dividend in July from $0.42 to $0.43 per share. The annual dividend of $1.72 presently yields 11.42%.

Despite the positive news, on July 31, Piper Sandler analyst Crispin Love downgraded Arbor Realty Trust two levels, from Overweight to Underweight, and announced a $16 price target.

The analyst was concerned that Arbor Realty Trust had reported an increase in nonperforming loans this past quarter and noted that the credit environment over the next several quarters is likely to worsen once interest rates begin to move lower. The analyst also felt that the stock, which had run up in price, was overextended.

Arbor Realty Trust has pulled back in recent weeks from $17.28 to $15.05. Despite losing 9% last week, Arbor Realty Trust is still the second-best-performing mREIT over the past year with a total return of 10.96%.   

Rithm Capital Corp. RITM is a New York-based mREIT created in 2013 that owns a diverse portfolio of operating companies, investments and private capital. Its primary functions are mortgage servicing rights (MSRs) and managing other mortgage-related assets. MSRs are contractual agreements in which the original lender sells the mortgage servicing to another company, which then administers the mortgage for a fee.

On Aug. 2, Rithm Capital reported second-quarter operating results. Non-generally accepted accounting practices (GAAP) EPS of $0.62 beat the estimates of $0.36 and were 100% above EPS of $0.31 in the second quarter of 2022. Revenue of $1.04 billion beat the estimates of $185.09 million but was 21.2% below revenue of $1.32 billion in the second quarter of 2022.

On July 24, Rithm Capital agreed to acquire alternative asset manager Sculptor Capital Management Inc. SCU in a $639 million transaction in which Rithm agreed to pay $11.15 in cash per Sculptor class A share. But on Aug. 20, a group of hedge fund investors, including Bill Ackman, Boaz Weinstein and Marc Lasry, made an offer to buy Sculptor Capital Management for $12 per share. Last week a group of Sculptor Capital shareholders said the agreement to be acquired by Rithm Capital substantially undervalues the fund.

Rithm Capital has the third-highest one-year total return of all mREITs at 8.38%. It pays a quarterly dividend of $0.25 and the annual $1 dividend yields 10.42%.

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