Small-Cap Commercial Mortgage REITs: Valuations Continue to Exhibit High Risk/Reward Characteristics

Commercial real estate is believed by many to hold the greatest risk within the mortgage REIT industry, and possibly within the financial and real estate sectors. Of course, with significant risk comes the opportunity for significant losses or gains.

Bad loans and bad tenants complicate the industry. Moreover, history indicates that commercial real estate often falls after the residential real estate market. Several investors, as a consequence, still expect commercial real estate to sustain its own separate, subsequent and consequential fall on the back of additional failing businesses and a lack of new commercial business coming in to replace them.

Commercial mortgage REITs are far more complex than residential ones, because their mortgages are more complex. The parties on both sides of the transaction are usually savvy and come to the negotiating table with lawyers, insurers and accountants. The terms are usually more complicated and the occurrence of incestuous relationships, where the borrower and lender have some close connections, is common. The issues make it difficult to conclude with any certainty when a default will trigger action, as terms are more likely to be re-negotiated between family and / or where no other tenant is likely to replace them.

Below are seven small-cap REITs that have exposure to commercial mortgages, though not necessarily exclusively or to a majority, depending on their present portfolio mix. Generally, there is an industry divide between residential mortgage REITs and commercial mortgage REITs. Many of these REITs can change their mortgage asset mix, and have in the past. The group offers yields ranging from zero to over 15%, and several with values near or well below book.