Stocks to Watch: Mortgage REITs

By Markets Fool.com

A small group of companies hidden within the mortgage real estate investment trust sector is gaining popularity. Unlike the traditional mREIT business model, which is nothing more than a portfolio of fixed-income securities, commercial mortgage REITs are true operating businesses. In essence, these companies are worth more than the sum of their parts, and they can build competitive advantages that most mREITs couldn't dream of.

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Today, I have had my eye on two in particular:Blackstone Mortgage Trust (NYSE: BXMT), and Ladder Capital (NYSE: LADR).

Blackstone Mortgage Trust
Sporting a sizable 6.8% yield, Blackstone Mortgage is in the business of acquiring and originating mortgage loans to businesses for commercial properties (hotels, office buildings, etc.).

Most important, commercial lending is intensely competitive. So, as CEO Michael Nash wrote in his 2013 letter to shareholder,"we often find relative value in larger transactions where competition is thinner." As of the first quarter, Blackstone Mortgage's average loan size was $83 million. This advantage -- the ability to finance large transactions -- stems from the Blackstone name.

The company is externally managed by a subsidiary of theBlackstone Group, and there are some serious advantages to being in bed with one of the world's largest asset managers (Blackstone currently has over $310 billion in assets under management). This includes immediate credibility, as well as access to resources, relationships, expertise, and a global investments platform.

For example, Blackstone announced on April 10 that it was joiningWells Fargoto acquire $23 billion worth of real estate assets from GE Capital. Blackstone Mortgage Trust received $4.6 billion of the mortgage loans from that deal. This doubled the size of the company's portfolio, and it is just a small taste the benefits of being a member of the the Blackstone family.

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With that said, Blackstone Mortgage is a little one dimensional for my taste. The company makes loans toward various types of properties, and its loans are also geographically diverse (they include some in Europe), but its business starts and ends with making commercial mortgage loans. This is a great business when loan demand and the economy are strong, but that will be cyclical over time. Before I consider buying, I would like to see the company expand its scope of business and create more avenues to invest capital.

Ladder Capital
Currently yielding 5.5%, Ladder Capital's business model of acquiring and originating commercial mortgage loans is similar to that of Blackstone Mortgage. However, there are a couple substantial differences.

One of the largest is that the company is internally managed. So, instead of receiving a fee based on shareholders' equity or assets under management, executives are compensated based on performance. This helps to align the management's interests with shareholders'.

Moreover, the combined holding of the executives total 13.3% of the company, which is a ton of skin in the game. In fact, the CEO alone owns 5%. For comparison, the combination of 12 executives and directors at Blackstone Mortgage own less than 1%.

Second, I like the company's diversity. As you can see in the chart below, Ladder has several different channels to invest capital.

The largest chunk of income comes from originating loans and holding them on their balance sheet. The slightly smaller piece comes from its conduit business, which involves originating loans and selling them off to an entity that packages them into commercial mortgage-backed securities. This is an intriguing business because Ladder earns a small profit for collecting and selling the loans, rather than having to take the risk of holding the loans to maturity.

The company also makes equity investments. This includes owning and leasing $850 million worth of commercial real estate properties.

Ultimately, having a wider range of opportunities to invest capital, as well as being internally managed, are big selling points; but I do have some modest concerns. One of which is that the company isn't supported by a Blackstone, so it does not have the same name recognition, as many established relationships, or the global platform to effectively scale in size the way I imagine Blackstone Mortgage Trust might.

Two to watch
Due to their unique business model, which allow them to build relationships and create unique assets, I think commercial mortgage REITs will have substantial opportunity and are an enticing high-yield investment. For the time being, however, I will hold off on investing in either company. But I will be adding both to my Motley Fool CAPS account to keep a closer eye on them.

The article Stocks to Watch: Mortgage REITs originally appeared on Fool.com.

Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.