The Federal Reserve interest rate hike of the new tightening cycle finally came in December, but global economic growth weakness may now mean that future rate hikes are already on hold. While most investors are now focused on the implications for bank stocks, Blackstone Mortgage Trust (BXMT) REIT may be the best under-the-radar way to play a lower-than-expected interest rate environment.
The Obvious Choice Isn’t BXMT REIT
BXMT isn’t the obvious interest rates play, but that doesn’t mean it’s not the play. Let’s get the obvious play out of the way: banks. Yes, banks are certainly hurt by lower interest rates. Banks rely on net interest margins to make profits, and margins are limited in a low-rate environment.
Unfortunately, selling bank stocks is such a good idea that the entire market has already beaten you to it at this point. So far in 2016, the Financial SPDR (XLF) is down 10.4%, and rate-sensitive bank stocks like Bank of America (BAC), State Street (STT) and Bank of New York Mellon (BK) are all down 13% or more. These stocks could all have more downside, but it appears to be limited at such cheap valuations.
The same story can be said for life insurance stocks as well. The high-quality bonds that represent a large amount of life insurers’ income now seemed destined to remain at historically low yields for the time being. Because life insurers can collect premiums for decades before having to pay out a claim, they rely more heavily on this type of fixed income than other types of insurers. Unfortunately, life insurance stocks like Lincoln National (LNC), Prudential Financial (PRU) and MetLife (MET) are also already down more than 16% each this year and now trade at forward P/E ratios below 7.
Stick with me. I’m getting to REITs, and BXMT specifically.
An Extreme Example
If banks and life insurers are out, where else can investors look for plays on low interest rates? Back in January, Japan announced that it would be lowering interest rates into negative territory. Although the Fed likely won’t venture into negative-rate territory anytime soon, a look at the Japanese market reaction to the negative rate news could provide some insight into what sectors thrive in lower-rate environments.
Not surprisingly, the worst-performing sector in Japan since the announcement has been financials. However, the two best-performing classes have been gold and real estate.
That leaves real estate — and the likes of BXMT — which is where the best potential low-rate buying opportunity for U.S. investors currently stands.
BXMT REIT The Perfect Opportunity?
Surprisingly, the iShares Dow Jones US Real Estate ETF (IYR) is actually down 4.6% year-to-date. Among the names that have sold off this year is BXMT REIT, a high-yielding commercial mortgage REIT. BXMT REIT is currently trading at nearly a 10% discount to its book value, which is an excellent deal.
And while earnings per share of the Blackstone Mortgage Trust, as well as the dividend, have both nearly doubled since the beginning of 2014, BXMT stock is down roughly 7% during that time. Even as the market has begun to price in the belief that interest rates may not be rising as quickly as anticipated, BXMT REIT and its 10% yield is trading down 7.5% so far this year.
The Bottom Line
The market selloff so far this year has already priced in the possibility of a pause in rate hikes when it comes to bank stocks, gold stocks and life insurance stocks. However, lower rates may also mean that REITs, particularly ones with juicy yields, will once again gain favor in the market. With solid growth, a high yield and a more-than-reasonable valuation, BXMT REIT looks like one under-the-radar beneficiary from a continued low interest rate environment.
As of this writing, Wayne Duggan was long BAC.