Best Mortgage REITs

Mortgage Real Estate Investment Trusts (mREITs) are a unique segment of the REIT industry that focuses on investing in real estate-backed loans rather than physical properties. These entities generate income primarily through interest on mortgages, mortgage-backed securities (MBS), and other real estate financing instruments. Unlike equity REITs that own and manage properties, mREITs thrive in the financial space of the real estate market, acting as lenders or investors in mortgages.

Known for their high dividend yields, mREITs appeal to income-focused investors. However, their performance is closely tied to interest rate fluctuations, credit risk, and market volatility, making them a potentially higher-risk investment. Understanding the nuances of how mREITs operate and their sensitivity to economic conditions is key for investors seeking to capitalize on this unique real estate investment vehicle.

What Are Mortgage REITs?

Mortgage REITs, or real estate investment trusts, are companies that invest in and manage mortgage-backed securities (MBS) and other real estate-related assets. These companies primarily focus on investing in residential and commercial mortgages, generating income from the interest payments on the loans they hold.

Mortgage REITs differ from traditional equity REITs, which primarily invest in physical properties such as office buildings, apartments, and shopping centers. Instead, mortgage REITs invest in the debt side of real estate, providing financing for property owners and earning income from the interest on those loans.

These trusts typically finance their investments through short-term borrowing at low interest rates and aim to generate income through the spread between the interest paid on the mortgages they hold and the interest paid on their borrowings. The income generated is then distributed to shareholders in the form of dividends.

Investing in mortgage REITs can offer investors the opportunity to earn high dividends, as these trusts are required to distribute a significant portion of their taxable income to shareholders. However, they also come with risks, such as interest rate fluctuations, credit risk, and changes in the real estate market. It is important for investors to carefully consider these risks and conduct thorough research before investing in mortgage REITs.

How Do Mortgage REITs Work?

Mortgage REITs purchase debt secured by real estate instead of investing in real estate directly. They generate income from the interest paid on the loans they invest in.

You may wonder how a mortgage REIT can pay a dividend of over 7% when mortgage rates are so low. The answer is that they don’t use their own money. They use short-term loans to borrow money at extremely low rates and buy loans that are paying the higher long-term rates. Then they have to constantly refinance that short-term debt, which is where the risk comes in.

Because mREITS typically invest in long-term loans, the interest they receive stays pretty consistent. This becomes a problem when short-term rates start to catch up with long-term rates. When this happens, the REIT’s margins get squeezed, and profits tank.

Pros of Mortgage REITs

Mortgage REITs offer unique advantages, particularly for income-focused investors. Here are some key pros:

• High Dividend Yields: mREITs are required to distribute at least 90% of their taxable income to shareholders, often resulting in significantly higher dividend yields compared to equity REITs or traditional stocks.
• Passive Income Opportunity: With their focus on interest-generating assets like mortgages and mortgage-backed securities, mREITs can provide a steady source of income, especially in favorable interest rate environments.
• Diversification: Investing in mREITs adds exposure to the financial side of the real estate market, complementing investments in equity REITs or physical properties.
• Accessibility: mREITs provide an affordable way to invest in the mortgage market without directly owning or managing mortgage loans.

Cons of Mortgage REITs

Mortgage REITs (mREITs) come with several risks and drawbacks that investors need to consider:

• Interest Rate Sensitivity: mREITs are highly sensitive to interest rate fluctuations. Rising rates can increase borrowing costs and reduce profit margins while falling rates can decrease the income from adjustable-rate mortgages​.
• Market Volatility: mREITs are more volatile than equity REITs due to their reliance on financial instruments. External factors like economic instability or sudden market changes can significantly impact their performance​.
• Leverage Risks: mREITs often use high leverage to boost returns, which can amplify losses during unfavorable market conditions or sudden changes in interest rates​.
• Dividend Instability: While mREITs are known for high dividends, payouts can be inconsistent due to fluctuations in earnings and changes in the interest rate environment.
• Tax Implications: mREIT dividends are taxed as ordinary income, which can lead to higher tax liabilities compared to qualified dividends from equity REITs​.

Best Mortgage REITs Right Now

Here are the best mortgage REITs to invest in today.

Are Mortgage REITs a Good Investment?

Mortgage REITs can be a good investment for income-focused investors due to their typically high dividend yields. They generate returns by earning interest from real estate-backed loans and mortgage-backed securities. Investors just have to remember that they are an inherently high-risk investment and extremely sensitive to interest rates.

Investing in Mortgage REITs 

Mortgage REITs can provide an excellent source of passive income for investors. However, it’s important to keep a close eye on your investments to anticipate any major change in stock price or dividends. Keep in mind that mortgage REIT stock prices are volatile. If prices drop, but overall fundamentals remain stable, you may want to take the opportunity to pick up more shares instead of selling out of panic. 

Frequently Asked Questions