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Real estate investment trusts (REITs) are businesses that invest in real estate and other property assets. Since real estate is such a popular financial sector, purchasing real estate and using it to trade stocks or rent or sell properties can be profitable.
REITs are notorious for their ability to increase earnings across a wide range of real estate sectors. Individual investors can buy stock in REIT companies, which gives them a piece of the real estate pie without forcing them to purchase properties.
This guide will give you an overview of the world of mortgage REITs (mREITs) and help you to decide whether this is a good option for your finances.
Mortgage REIIT (mREIT) Definition
Mortgage REITs or mREITs are REITs that focus on mortgage-related assets. Unlike equity REITs, they are not involved in property ownership, management, or development; instead, they make money through interest from loans.
How Mortgage REITs Work
mREITs primarily invest in agency MBS, but some also have exposure to non-agency MBS. Agency MBS interest rates are often lower than market rates since the federal government insures the bonds.
With support from the federal government, real estate investments quickly became a popular option for financial diversification.
When borrowed funds purchase an asset that generates income, it is called a carry trade. This is the primary method that mREITs use to make money.
Assuming no unexpected events cause MBS prices to drop, the carry trade will be lucrative. The interest rates on agency MBS tend to be low because the bonds have guaranteed funding.
Consequently, to pay out high dividends to investors, mREITs use leverage by creating debts and investing the proceeds in MBS.
Mortgage REIT leverage
mREITs rely heavily on short-term collateralized loans, or repurchase agreements, as a source of debt financing. During a repurchase transaction, an mREIT will sell its portfolio to a lender.
The lender then exchanges the MBS for immediate cash. The company will purchase more mREIT stocks and then repurchase the other securities later at a better price.
The lender of the MBS earns interest, which is equal to the spread between the sale and repurchase prices of the security.
When an mREIT borrows money to acquire MBS, the MBS then becomes collateral against the new debt. As the debt levels of mREITs may be as much as ten times their book value, companies often leverage them.
The book value is calculated by deducting the value of an organization’s assets from its total liabilities, preferred stock, and intangible assets.
As a result of high levels of leverage, mREITs often use hedging contracts to stabilize the cost of their debt financing. mREITs might receive a higher net interest spread by hedging their loan expenses.
They may also increase the return on MBS, yet they pay dividend rates of over 10% because of their use of borrowing.
Examples of Mortgage REITs
Investors may put their money to work for them by investing in corporations like these. The companies will take the investor funds and use them to purchase real estate and stock options and pay investors dividends when they sell those properties or collect other interest.
Equity REITs vs. Mortgage REITs
Though they are both REITs, there are a few key differences between mREITs and equity REITs.
Equity REITs invest in and manage rental properties to collect rent payments. Because of the reliability of their earnings, they have widespread recognition.
Since they profit from collecting rent, they are a safer investment option but lack high earning potential.
mREITs are REITs that specialize in buying and holding mortgages and other mortgage-related assets. Their famed dividends mostly come from interest earnings. mREITs are more of a niche product than equity REITs.
Benefits of Mortgage REITs
mREITs can be a fantastic way to diversify your finances by investing in a company that will help you earn the maximum amount of profit.
There are a few important benefits that mREITs are well-known for:
- High-dividend yields: Some investors place a premium on passive income above all others. High-yield investments are prevalent among retirees because they aim for passive income. Once you invest in an mREIT, you don’t have to do any more work to profit from your investment.
- Low minimum investment: The price of a single share in a REIT might be as low as $5 or $10. This is quite the deal compared with making a $40,000 down payment on an investment property.
- Diversification: If you’re looking to diversify your portfolio, these firms make investing in real estate easy and accessible, even if you don’t have a lot of excess funds. By investing in various options, you can earn passive income and some backup profits.
- Liquidity: Buying and selling shares in REITs is quick and easy, unlike buying and selling real estate, which may cost thousands of dollars and take months.
- No corporate tax: By law, REITs are exempt from paying corporate taxes if they return at least 90% of their earnings to shareholders. This means that shareholders may keep more of their money instead of spending it on taxes.
Risks of Mortgage REITs
Several factors make mREITs riskier than other REIT investments:
- Interest rate risk: Because both short- and long-term interest rate changes may impact net interest margins by raising borrowing costs and decreasing interest revenue, interest rate fluctuations disproportionately impact mREITs. Interest rates may also affect the value of an mREIT’s mortgage assets, which in turn can influence the value of the mREIT’s net assets and price of its shares.
- Prepayment risk: Borrowers with a mortgage might either refinance their debts or sell the property. The mREIT will have to reinvest the money from the loan repayment into the market at whatever interest rate is available, which might be lower than the mortgage’s current rate.
- Credit risk: Credit risks posed by defaulting borrowers might affect mREITs specializing in commercial mortgages. Government-backed mREITs are less vulnerable to this risk.
- Rollover risk: Loans for private dwellings’ long-term mortgages and MBS are joint holdings for REITs. Nonetheless, corporations often borrow for shorter periods rather than longer ones to finance these acquisitions since short-term interest rates are typically cheaper.
There is a rollover risk in this kind of financing. To keep their loans from maturing, mREITs need access to cheap money.
That means they may be unable to keep your investment for long, so you will have to find different mREIT stocks for investing.
3 Best Mortgage REITs to Invest in 2023
Many of the several dozen mREITs have lagged in the S&P 500 in recent years owing to interest rate fluctuations.
However, a few mREITs stand out as attractive contenders in this volatile market and may be ideal for patient investors who desire high-income streams.
Blackstone Mortgage Trust (BXMT)
North American, European, and Australian commercial real estate serve as collateral for senior loans from Blackstone Mortgage Trust, Inc.
The primary investment strategy of the company is to produce dividends from current revenue. The company uses funds from its loan portfolio to preserve and protect shareholder capital while generating excellent risk-adjusted returns.
It operates as a real estate investment trust for U.S. federal income tax purposes. You know BXMT will back your loan with high-quality, institutional properties in primary markets.
Its investors include seasoned, well-capitalized real estate investment owners and operators, proving their reliability.
- Type of Investments: Primarily loans on significant market assets with top sponsors
- Markets: New York Stock Exchange (NYSE)
- Best For: Long-term investors
VanEck Mortgage REIT Income ETF (MORT)
VanEck Associates Corporation manages the VanEck Mortgage REIT Income ETF, an exchange-traded vehicle. Before fees and costs, the investment aims to match the price and yield performance of the MVIS® US Mortgage REITs Index as closely as possible.
At least 80% of the fund’s total assets are typically placed in securities that make up the benchmark index. Companies of varying sizes may appear in the Mortgage REITs Index.
However, the fund is not diversified.
- Type of Investments: Stock in companies
- Markets: NYSE
- Best For: Beginner investors
Ellington Residential Mortgage REIT (EARN)
Ellington Residential Mortgage REIT acquires, invests in, and manages residential mortgages and other tangible estate-related assets. It buys and oversees a variety of residential MBS (RMBS), including both agency and non-agency pools and collateralized mortgage obligations (CMO).
The corporation is a REIT, which means it doesn’t have to pay taxes and can give more dividends to its shareholders.
- Type of Investments: Mortgage-related assets, RMBS investments
- Markets: NYSE
- Best For: Long-term investors
How to Invest in Mortgage REITs
If patient investors fare well in the REIT industry, how does one go about investing in mREITs specifically? Putting money into mREITs is a simple process.
To invest in publicly listed mREITs, simply open a brokerage account and purchase shares. The actual difficulty of mREIT investing lies not in the investing itself but in selecting high-quality mREITs.
You must be careful when determining whether an mREIT is suitable for your portfolio.
Is a Mortgage REIT a Good Investment?
Although mREITs may not be as well-known as equity REITs, they are worth paying attention to. mREITs are a fantastic investment option because of their diverse asset base, substantial dividend yields, and high-interest rates.
It’s important to remember, however, that not every mREIT is the same. Due to the volatility of their high returns, mREITs aren’t the ideal choice for individual investors, though a few mREITs have unique business strategies that assist them in weathering general market uncertainty.
You must invest carefully if you want to maximize your returns. mREITs may be a useful addition to your portfolio, but only if you do your research and carefully consider the pros and cons of each investment opportunity.
Contact your broker or financial advisor for additional information about mREITs and to see what options you might have for investing in these funds.
Mortgage REIT FAQs
Still have some uncertainties about mREITs? Here are some frequently asked questions that may give you the answers.
Are mortgage REITs good during inflation?
Mortgage income investors may find mREITs, or mortgage-backed REITs, an appealing option in the current context of increasing interest rates.
As a result of the cash flows they generate, mREITs often provide a higher yield than the S&P 500.
How do mortgage REITs make money?
Interest payments on mortgages and MBS are the primary source of income for investors in mREITs.
They often have greater dividend yields than others because of high-interest rates in the real estate market.
What is a good return when investing in a mortgage REIT?
For the entire year of 2021, investors in the 34 publicly listed mREITs that make up the Mortgage REITs Index maintained by the National Association of Real Estate Investment Trusts (Nareit) had a return of little over 15%.