Investing in Mortgage Securities
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A number of studies notably, Kolbe, et al ; Chandra, ; Kolbe and Greer, have focused on the importance of real estate investment trust REIT as a vehicle for real estate development finance.
Mortgage Backed Securities
According to Kolbe et al , Chandra , Kolbe and Greer , REIT has been identified as a vehicle for real estate finance, especially in developed nations. REITs operate like closed-end mutual funds and raise funds by issuing shares, bonds, commercial paper, and by borrowing from other financial institutions while also investing in real estate debt and equity. REIT offers several benefits over actually owning properties. First, they are highly liquid, unlike traditional real estate.
Second, REIT enables sharing in non-residential properties as well, such as hotels, malls, and other commercial or industrial properties. Third, there's no minimum investment with REIT. REIT does not necessarily increase and decrease in value along with the broader market. However, they pay yields in the form of dividends no matter how the shares perform.
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REIT can be valued based upon fundamental measures, similar to the valuation of stocks, but different numbers tend to be important for REIT than for stocks. This measures the value of the properties owned by the REIT is based on income generated. These securities are obtained from mortgaged assets and serve as debt obligations that represent claims to the cash flows from pools of mortgage loans, most commonly on residential property.
The entity then issues securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool, a process known as securitization. Securitization is the process of converting real estate into tradable instrument with the underlying asset as security. It is the creation of tradable paper interests in real estate as alternative to direct ownership of the assets, and involves the collection of large number of illiquid loans or receivables into pools that are used to collateralize securities for eventual sales to the investors Oni et al, According to Osaze , Mortgage-Backed Securities MBS are created when mortgages are pooled together and undivided interest or participation in the pool is sold.
The initiator of the MBS continues to service the original mortgages in the pool, collecting payments and sending across passing-through the principal and interest, less the servicing, guarantee and other fees to the security holders who share these cash flows on a pro-rata basis.
Part of the outstanding principal is paid monthly according to the amortization schedule of the individual mortgages. However, the principal can be prepaid without cost wholly or partially at any time before the maturity date of the security. The usual initiators or originators of MBS are commercial banks, savings and loans companies, finance houses and primary mortgaged institutions.
The principal and interest payments from the underlying mortgage loans provide the cash flow on the instrument to investors. Payment may be flexible-with allowance for prepayments or restricted- without allowance for prepayments and interest rates can also be fixed or variable. MBS is characterized by attractive yields, credit quality and pool of funds, tradable capital market instrument, and aids diversification of financing sources.
Walmsley, ; Adereti, Nubi in Emoh asserts that securitization entails the conversion of assets illiquid assets i. The introduction of securitization to real estate finance has in no small measure boosted real estate development all over the world. In the United States for instance, MBS have become the main vehicles for securitizing all the different types of mortgage instruments which are available to home buyers. In other words, whether the mortgage payment is made or not, the security holder is guaranteed full and timely payment of principal and interest.
Apart from holding loans which were purchased from the originations in its portfolio, it also securitises and sells mortgages. It pools mortgages from its purchases and issues MBS to initiators in exchange for pooled mortgages. This has resulted from its very active involvement and participation in the secondary market for mortgages.
This is evident in that developers who utilize securitization in financing real estate will have more funds made available outside the traditional channels; enjoy lower interest rate charges, long term finance and spread of housing development round the nation. Other benefits of MBS introduction are delivery of affordable housing, wealth creation for investors; expansion of the capital market with a multiplier effect of reinvigorating economic growth and stability; and will reduce employment problem by creating more jobs.
Given these benefits, there is hence the need to encourage this investment medium to meet low- cost housing finance as a significant proportion of the population cannot afford high profile properties. REITs have been in place in Nigeria since January and were introduced as a tax efficient vehicle which allows property investment companies to offer shares to the public.
In , the Nigerian Government announced plans to improve the efficiency of both commercial and residential property investment markets. Adetunmbi suggests that the use of REIT in Nigeria will transform the mortgage business and real estate development, will facilitate long term instrument vehicle for real estate equities and deepen the capital market, provide access to good and affordable housing and provide long term stable income for investors. What role can the government, housing finance associations and professional real estate associations play in expanding the pool of loan able funds for housing development in Nigeria?
Mortgage-backed securities and Real Estate Investment Trusts as alternative housing finance options have proved to be very effective vehicles for expanding housing funding in other countries, especially in the US. They can and will work here in Nigeria. It would appear that too many Nigerians believe in acquiring property rather than creating assets.
Mortgage-Backed Securities (MBS)
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.
Types of Bonds Print. MBS are usually based on mortgages that are guaranteed by a government agency for payment of principal and a guarantee of timely payment. The analysis of MBS concentrates on the nature of the underlying payment stream, particularly the pre-payments of principal prior to maturity.
Investing in Mortgage Securities
Before the development of the mortgage backed securities market in the early s, each residential mortgage underwritten was a unique transaction. Joe Q. Public would walk into his bank or trust company and enter into a mortgage. Say Joe chooses Lack Trust Company. Joe enters into a mortgage on a specific real estate property, Easy Street in the Hills of Richmond, with the good people of Lack Trust.
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Sounds easy. But think of what has to happen for this mortgage to be underwritten. Joe and Lack Trust then negotiate and establish the terms. This includes the amount and interest rate of the mortgage, the amortization of principal as well prepayment terms. Lack Trust then has to hire a lawyer to register the mortgage against the property with a property registry office. There are no other mortgages on Easy Street with Joe as the borrower on those terms and conditions. Most mortgages used to be held by the financial company that originated them because trading was awkward given that these unique mortgages had to each be evaluated and administered differently.
The originating organization usually kept the servicing and was loath to part with their mortgages.