Stocks may be overvalued and bonds are vulnerable to rising interest rates, but there’s another alternative that provides income, total return potential and relative principal stabilit—residential whole mortgage notes. Vertical Capital Markets Group CEO Gus Altuzarra and Vertical Fund Group President Christopher Chase explain this evolving asset class in a new white paper, The Case for Residential Whole Mortgage Loans.
To diversify a portfolio, it is important to include assets that are “non-correlated” with stocks or bonds; that is, they are not affected by the performance of those two asset classes. Although they have some sensitivity to interest rates, whole mortgage notes otherwise have little or no correlation with stocks or bonds, according to Altuzarra.
Whole mortgage notes produce income from the underlying mortgages. The investor also benefits from the “collateral gap” between the amount paid to purchase the note and its value when it is paid off or refinanced, or if the home is sold. The mortgages are typically purchased from lenders at a deep discount.
In addition, whole mortgage notes are collateralized with real property. Investors are creditors, just as if they were a bank. If a foreclosure is necessary and the property is sold, the investor may benefit. In such cases, the investor could still profit, because the amount the property is sold for may still exceed the discounted purchase price of the note.
“Add up the benefits: income potential, non-correlation, deep-discount total return potential, highly collateralized with real assets—and relative principal stability,” Altuzarra said. “You have the investment profile of a new asset class, residential whole mortgage notes, that is slowly, but steadily gaining visibility in the marketplace.”
Chase added that whole mortgage notes have an important difference from real estate investment trusts (REITs) and mortgage-backed securities (MBS).
“Rather than a promise to pay interest and principal to an investor on a timely basis, residential whole mortgage notes represent full ownership for cash of an underlying residential property,” he said. “When pooled together in an investment portfolio, these notes put investors in the role of creditor—just like a bank. And, just like a bank, monthly mortgage payments are directed through the funding vehicle to individual investors.”
