Equity REITs vs. Mortgage REITs: Not a level playing field when it comes to raising capital

by Casey Crow

As the Equity REITs raise big money the mortgage REITs are experiencing some hesitation among investors.

Over the past six months equity REITs have been on a tear raising money to poach distressed assets. With commercial lenders still on the sidelines, cash is the only way to get deals done. This year alone over $14 Billion has been raised by REITs, with most of that coming from the big players like Boston Properties, Simon Property Trust and Vornado.

This has been the glimmer of hope for the equity REITs in these dismal times. REIT risk managers and CFOs are likely thinking, “Well, if deals cannot get done now, we can at least raise some cash to scoop up some quality assets on the cheap”. Mortgage REITS on the other hand haven’t been so lucky.

As recent as this past week, we have seen a flood of mortgage REIT IPOs hit the market. These smaller, less capitalized, mortgage REITs have also been attempting to raise cash in an effort to capitalize on distressed assets, in their case, loans. Only a small proportion of all REITs are classified as mortgage REITS. Technically, these are finance companies that lend on real estate assets and use creative hedging activities to manage their risk exposure. They are more complicated and more risky than their equity brethren, and hence, are smaller and don’t carry the house hold name like some equity REITs do. These mortgage REITs are going after the now defunct CMBS market. With mortgage backed securities being the cause for this once-in-a-generation economic meltdown, no one wants to touch new CMBS offerings. This has led to low values placed on new CMBS deals, and a lot of mortgage REITs see an opportunity, sensing the CMBS packages may be under valued.

What we are seeing is the perceived value of “street cred” among investors. As far as raising capital goes, the bigger equity REITs didn’t have a problem. Despite the lack of funding, rising cap rates, and ramping vacancies the Vornados and Simon Properties of the world have always been well capitalized. They splurged like everyone else during the boom times and made some bad decisions, but they avoided getting over leveraged and were never in danger of default. Another advantage the equity REITs have going for them is dividends. Despite the recent cut-back by many REITs, the majority of them have been paying out steady dividends for years with above average yields.

The mortgage REITs have a few things going against them when it comes to raising capital: 1) They are purchasing risky mortgage backed securities, 2) They are highly leveraged entities, 3) All the recent chatter about commercial real estate being the next “shoe to drop” has soured many investors on the idea of investing in the commercial real estate market, and 4) Many are smaller organizations, and to generate capital quickly for opportunistic situations it helps to have a track record, it helps to have “street cred”. This is why many of the recent funds created by these mortgage REITs have seen dramatic cuts in value.