New Residential: A Different Kind of REIT

11/26/2015 7:00 am EST

Focus: REITS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Most REITs face financial headwinds as interest rates rise. The opposite is true for this recommended real estate investment trust, explains Ian Wyatt, of Million Dollar Portfolio.

New Residential Investment (NRZ) is an entirely different type of REIT. That's because this mortgage REIT is designed to reap bigger returns when interest rates rise.

New Residential is focused on a unique aspect of the business called excess mortgage servicing rights (MSR).

Excess MSRs allow the owner to collect extra fees above and beyond the actual cost of servicing the mortgage. New Residential buys these fee rights from other mortgage servicers. 

To maximize these fees, the company wants to own loans that are unlikely to be refinanced. Similarly, they want to own loans that won't go into default.

The company has focused its excess MSR portfolio on less credit-worthy individuals. That may sound risky, but it means these individuals will have trouble refinancing their loans.

At the same time, the company doesn't want to own loans at risk of default. If a homeowner doesn't have adequate skin in the game, he may simply walk away from an underwater mortgage.

The New Residential portfolio includes loans with an average duration of 106 months. That means the average borrower has been making mortgage payments for nearly nine years.

These folks have already seen the highs and lows of the housing boom and bust. They've had opportunities to walk away from an underwater mortgage. And they've had numerous chances over the last few years to refinance their mortgage to lock in lower interest rates.

This has been a superb business. The company has made an investment of $1.8 billion for these assets.

Thus far, it has provided $498 million in cash flow and an internal rate of return of 24%. Plus, the company expects $2.7 billion of future cash flows from these investments.

With an annualized dividend payment of $1.84, New Residential provides an attractive 15.2% dividend yield.

One positive sign is that CEO Michael Nierenberg has been buying the stock. Since mid-April, he's bought nearly $4 million of stock at $15.25 - $16.05 per share.

New Residential has a solid group of institutional shareholders, including Vanguard (6.3%) and BlackRock Fund Advisors (3.7%).

Leon Cooperman's Omega Advisors also owns a $102 million stake and has been buying more stock at recent prices.

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