New REIT ETFs Open Up Lucrative World of Commercial Mortgages

The iShares trust has filed with the SEC for the creation of ETFs that will track FTSE/NAREIT indexes:

• iShares FTSE NAREIT Residential Index Fund
• iShares FTSE NAREIT Industrial/Office Index Fund
• iShares FTSE NAREIT Retail Index Fund
• iShares FTSE NAREIT Mortgage REITs Index Fund
• iShares FTSE NAREIT Real Estate 50 Index Fund

The current set of REIT ETFs [iShares Cohen & Steers Realty Majors ETF (ICF), streetTRACKS Wilshire REIT Index Fund (RWR), Vanguard REIT VIPERs (VNQ)] all own only real estate investment trusts that own real properties, so-called equity REITs. These new ETFs chop up the REIT universe into finer sectors. To me, the most interesting ETF is the iShares FTSE NAREIT Mortgage REITs Index Fund.

People who own the current REIT ETFs are missing out on the lucrative world of commercial mortgage REITs, such as CapitalSource (CSE), Newcastle Investment Corp (NCT) and Resource Capital Corp (RSO).

Commercial MREITs are the main sector that has not participated in the REIT bubble. They are poised for growth as the interest rate environment becomes more favorable and banks dial back on commercial real estate/industrial lending. The current yields on MREITs average 8%, and multiples are still attractive compared to equity REITs (pass the bubbly for ICF).

Large commercial mortgage REITs like Capital Trust (CT), iStar Financial (SFI), and KKR Financial (KFN) have built profitable niches taking on large loans that are too specialized and tricky for banks to handle. Other MREITs like JER Investors Trust (JRT) and Anthracite Capital (AHR) work in structured finance and mezzanine lending. The combination of a lower cost of capital, match-funded leverage, and a longer investment horizon gives MREITs more investment flexibility than other players. Highly recommended.

Full Disclosure: I am long JRT.