No. of Recommendations: 15
Just to set the record straight, we do currently own small quantities of the following MREITs:

Colony (CLNY)
Colony Preferred A (CLNY-pA)
Starwood (STWD)

The main common characteristic of these two MREITs is that they have very low leverage, compared to typical MREITS like NLY, CIM and AGNC. Those typically have 4 to 8X leverage.

Colony and Starwood typically have less than 1.4X leverage, which is a world apart. Could they still get into trouble, even with the lower leverage, the answer is yes.

Colony and Starwood also both hold "different" types of paper from the typical MREITs. They own mezzanine paper, some commercial firsts, and some distressed firsts on both commercial and residential. In addition, CLNY has added owning single family residences to their portfolio.

In both of these companies, we are 100% dependent on management leading with the best interests of shareholders. There is NO way private investors can say if they have their paper properly valued. What is a defaulted mortgage on a bowling alley in Des Moines, Iowa worth? There is only one loan like this in the world. It is not like a Fannie/Freddie mortgage bond that has an active buy/sell market. In that case, the market tells you every day what the paper is worth.

If you own CLNY/STWD you have implicitly trusted management to fairly value the paper they buy plus have some clairvoyance of its future value. The low leverage does give them some room for error without bankrupting the MREIT.

I also like the recent STWD acquisition of a “special servicer” company, LNR property. In case you are not familiar with commercial loans, the mediator is a “special servicer.” Typically when you make say a $100 commercial loan on an office building, the loan documents will have provisions on what to do if the loan payments are not made. Instead of sending the county sheriff out to evict the tenants like a residential property, the special servicer springs into action. His job is to determine the best path to get the loan paid off. It is more of a negotiation/mediation process. I am sure Pariseur/Ron/LanRes and the pros know a lot more about special servicers than I do. Long story short, by Starwood owning a leading special servicer like LNR is a big plus IMO. It should help bring them more investment opportunities.

I do consider these investments at the outer limits of risk for the widows and orphans portfolios. We do NOT have a high allocation to them.

I have NO problem with anybody owning NLY/CIM/AGNC IF they understand the risks. What I don’t like is when unsophisticated investors buy them strictly for yield, then end up losing a lot of money.

If you asked 100 NLY investors what they should expect if the yield curve inverts, I expect 90% of them would look at you like you are from Mars. They would be clueless about both the yield curve, plus the margin impact on the MREIT. These are the folks that I worry about. . .


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