is the industry classification methodology that both companies rely on for their proprietary stock market indexes. And it serves as one of the primary classification systems for equities for investors around the world.”
Another enormous year was 2020, though on the downside in many ways. As Covid‐19 spread from China out into the West, governments around the world began shutting down group gatherings, including those held in office buildings, hotels, malls, shopping centers, and so many other REIT‐held properties. Some of them literally couldn't open for months on end, forcing dozens and dozens of dividend cuts and other measures taken to prevent total collapse.
Through October 2020, 65 equity REITs either cut or suspended their dividends because of this, with most of the volatility seen in the lodging, retail, office, and healthcare spaces. We'll explore how that global pandemic impacted REITs on a subsector level over the course of the next several chapters.
Lending REITs Versus Ownership REITs
If you recall, REITs don't have to own real properties. They're also allowed to originate, acquire, hold, and even securitize real estate mortgages – such as those backed by residential or commercial properties – and related loans. As of July 31, 2020, there were 35 mortgage REITs, with 21 focusing on the residential side and 14 on the commercial. Hybrid REITs, which both own properties and hold mortgages on others, were popular some years ago. But they're not widely prevalent today.
In the late 1960s and early 1970s, lending REITs were exceptionally popular since many large regional and “money‐center” banks and mortgage brokers formed their own real estate–specific institutions. Almost 60 came to life back then, most of them lending funds to property developers. That worked well enough until interest rates rose substantially in 1973, causing a crash in demand for new developments. Nonperforming loans then spiked to fearsome levels, and most of these entities crashed and burned, leaving investors in the lurch.
A decade later, a new round sprang up to invest in collateralized mortgage obligations (CMOs), only to suffer a similar end.
A number of mREITs – particularly the residential kind – also performed very poorly in the Great Recession, though that didn't stop many new ones from forming. As hundreds of traditional bank failures ballooned, big private equity companies seized the opportunity to lend to property owners. And several other players with more specialized lending platforms also emerged in the wake.
Today, I'm happy to say that the quality of mREITs has improved substantially. However, they still present several challenges, starting with their tendency to be more highly leveraged with debt than their equity counterparts. This increased leverage can make earning streams and dividend payments much more volatile. Plus, they tend to be more sensitive to interest rates. A general increase or even a significant change in the spread between short‐term and long‐term levels can impact earnings substantially. And, because they don't own easily valued real estate, valuing their shares can be equally tricky.
They also lack the transparency you get with traditional equity REITs. So you rarely see them providing street addresses in their investor presentations. In short, mREITs are perhaps best viewed as trading vehicles whose business strategies, balance sheets, and ties to interest rates must be constantly and carefully monitored. They can be good investments, particularly if well managed. But they're a specialty niche in the REIT world nonetheless.
Accordingly, most conservative long‐term investors prefer their counterparts instead. That's why, going forward in The Intelligent REIT Investor, the term REIT will refer exclusively to the equity kind.
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