Real Estate Investment Trusts (REITs) are funds used to borrow money to buy mortgages and mortgage-backed securities, and now the Securities and Exchange Commission (SEC) is reviewing whether use of these investment funds is an abuse of their exemption from regulatory restrictions that have now been imposed on banks to avoid financial crises. The review is already causing REIT share prices to fall and industry players have commented that placing borrowing limits on REITs could defuse their market demand for mortgages and further harm the housing market. For more on this continue reading the following article from The Street.
A move by regulators to review rules governing real estate investment groups in the U.S. has sparked concerns over an important source of mortgage funding. The Securities and Exchange Commission is looking at whether Real Estate Investment Trusts, or Reits, should enjoy a special status that has allowed them to take more risk than typical investment funds. Reits, which borrow money in short-term markets to buy mortgages and mortgage-backed securities, have become a pillar of U.S. mortgage finance as restrictions on banks and Fannie Mae and Freddie Mac’s capital have tightened.
Their shares had been outperforming equity markets, thanks in part to their widening dividend yield premium over Treasuries. The Bloomberg Mortgage Reit index yields 14.8%, versus 2% on 10-year Treasuries.
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But the shares have lost their lustre following the SEC’s announcement earlier this month that it was to look at the status of Reits. The Bloomberg Mortgage Reits index gained 2.3% in August, against the broader S&P 500 index’s 5.7% decline. The Reits index has erased that gain so far in September, falling 2.2%.
The SEC said the exclusion of Reits from rules for typical funds, including limits on borrowing, could raise the potential for abuses "such as deliberate misvaluation of the company’s holdings, extensive leveraging and overreaching by insiders". Rich Moore, analyst at RBC Capital Markets, said that the risks from new rules included eliminating some of the tax advantages of Reits. "The issue is front and centre for the sector," he said.
Chris Flanagan, head of U.S. structured finance research at Bank of America Merrill Lynch, said that a sharp decline in Reits’ share prices would impair their ability to borrow and could decrease the leverage available to buy mortgages. "The impact on the mortgage market could come if the steady demand from Reits slows down," he said. The SEC is currently collecting comments on its proposal. Dozens of retail investors have written in to oppose any changes, though funds and members of the industry have yet to comment. Analysts at FBR Capital Markets said they expected regulators to make sure any rules did not slow the buying of mortgages. "[The SEC] does not want to prevent the formation of capital," they said. Since the beginning of 2010, Reits buying agency mortgages have raised $15 billion via equity offerings, according to Bank of America Merill Lynch. Some $200 billion of the roughly $5,000 billion agency mortgage market is owned by Reits. Michael Farrell, chief executive of Annaly Capital Management, the largest U.S. mortgage Reit, said: "We support the establishment of a clear and comprehensive set of best practices … to preserve [Reits’] traditional role in capital formation for residential housing."
This article was republished with permission from The Street.