What are Mortgage REITs?

The post What are Mortgage REITs? by Eric McConnell appeared first on Benzinga. Visit Benzinga to get more great content like this.

While equity REITs own and manage real estate properties to generate rental income, Mortgage REITs (mREITs) invest in and own mortgage loans. They provide the financing for real estate and in turn generate income from the interest.

Real estate investment trusts, also known as REITs, have long been a favorite for investors. This is because of their ability to perform in adverse conditions while also generating passive income for investors. Although most people immediately think of residential or commercial REITs when it comes to this sector, mortgage REITs are also worth a look.

How Do Mortgage REITs Work?

Mortgage REITs are real estate investment trusts that use investor capital to fund mortgages or purchase mortgage-backed securities (MBS). Mortgage REIT investors then earn income from the interest on the mortgages included in the REIT. Examples of the kinds of assets you might typically find in a mortgage REIT include:

• Residential mortgages 
• Commercial mortgages
• Securities backed by residential mortgages
• Securities backed by commercial mortgages
• A combination of securities backed by both residential and commercial mortgages

In addition to relying on interest earned from mortgage-backed securities to generate returns, many mortgage REITs (mREITs) also own income property. 

Benefits of Mortgage REITs

Although equity REITs might get a greater share of the attention, mREITs also offer investors a wealth of benefits. 

Passive Income

Like all REITs, mREITs offer investors the ability to generate passive income. As opposed to equity REITs, which pay investor dividends from collected rents, mREITs pay investors through the interest from the loans. This allows investors to build wealth without having to worry about collections and the legwork that actually goes into servicing loans. Additionally, mREITs make money off of mortgage loans, which is an incredibly lucrative investment sector. 

Liquidity

One of the downsides of traditional equity REITs is that the assets in the REIT can be difficult to liquidate. Equity REITs mostly consist of institutional assets, which means that if there isn’t another institution or REIT that wants to buy the asset, the REIT could have difficulty moving it. 

By contrast, the mortgage-backed securities that make up most mREITs are much easier to move when necessary. That has a lot to do with the fact that potential buyers know the loans are secured by real estate assets. Agency-backed mortgage securities in particular are very liquid because they are guaranteed by the federal government. 

Increased Investor Security

As noted above, mREITs mainly consist of mortgage-backed securities. If the borrowers default, the real estate backing the loan can still be liquidated to pay off investors. When it comes to agency-backed securities, the federal government backing that makes them so liquid also provides increased security for investors.

Dividends

Another big potential advantage of mREITs is that they tend to pay higher dividends than equity REITs. While a solid dividend yield from an equity REIT might be in the 3% to 5% range, many mREITs pay out at a 6% annual rate, and some of them can reach as high as 10%.

Necessity

Mortgage lending is the key to America’s real estate industry. At any given point, there are millions of mortgage loans actively making money. Without this lending, the real estate industry would come to a screeching halt. When you invest in an mREIT, you’re not only investing in one of America’s bread-and-butter economic engines, you’re helping boost the economy as a whole.  

Risks of mREITs

Investing in mREITs is not without risk. 

Interest Rates

Most mREITs use short-term debt to buy the securities they depend on for money. As a consequence, mREITs can be very sensitive to fluctuations in interest rates. When rates rise, the cost of refinancing existing debts carried by the mREIT increases. That eats into profits and lowers investor dividends. 

On the other side of the equation, rapidly falling interest rates can pose a different kind of threat to mREITs. When rates fall, it becomes easier for borrowers to pay off their loans early or refinance them. Both of these potential outcomes can have an adverse effect on the dividends earned by REIT investors. 

Borrower Default

Every loan in every mREIT is a potential opportunity for default. Although mREITs may account for a small percentage of borrower defaults, mass defaults caused by a declining economy is a real problem for mREIT investors. When borrowers aren’t paying their mortgages, there is no interest income for mREITs to pay investors.

This is especially true in the case of loans that aren’t agency-backed because there is no government backing. That means if there is a default, the mREIT is left holding the bag. Historically, the mortgage default rate is fairly low, but the risk is always a factor for mREIT investors. 

How to Invest in mREITs

Investing in mREITs is simple. Many of them are publicly traded, which means you can buy them through a brokerage app the same way you can any other stock. One great place to start your search for mREIT investment opportunities is this list of Benzinga’s best online stock brokers.

Largest Mortgage REITs

Annaly Capital Management Inc. (NYSE: NLY)

Annaly Capital Management is one of America’s largest mREITs. This REIT has been in operation for nearly 25 years and is nearly 14 times larger than the average-size mortgage REIT. This large size allows them to operate with a heavily diversified portfolio. 

Starwood Property Trust Inc. (NYSE: STWD)

Starwood Property Trust is an mREIT that focuses on mortgage-backed securities and mortgage origination in the commercial real estate sector. Its 2009 IPO was the third-largest REIT IPO in U.S. history and at the time, made it the largest blind pool company to ever be listed on the New York Stock Exchange. Since the IPO, Starwood has lent more than $51 billion in capital and acquired $2.4 billion in equity in commercial real estate assets. 

Starwood has a highly diversified portfolio that includes:

• Multifamily
• Hotels
• Office
• Industrial
• Retail

Starwood has a heavy focus on risk mitigation through diversification. Its current share price is lingering around $20 and it has a total market capitalization well over $6.628 billion. 

AGNC Investment Corp. (NASDAQ: AGNC)

AGNC is America’s second-largest internally managed residential mortgage mREIT. It specializes in agency-backed securities and is one of only two mREITs with a market cap just over $6 billion. AGNC’s management model prioritizes efficiency and cost management, which is why its operating expenses are only 0.08% of its equity capital.

Its current portfolio is worth an estimated $61.5 billion, and the assets break down as follows:

• ~92% or $54.6 billion in 30-year fixed mortgages
• ~3% or $1.7 billion in 15-year fixed mortgages
• ~3% or $1.7 billion in credit risk-transfer (CRT) and non-agency mortgages
• ~2% or $1.5 billion in 20-year fixed mortgages
• ~1% or $300 million in constant maturity treasury (CMT) and adjustable-rate mortgages

Mortgage REIT ETFs

Investors can also gain exposure to mortgage REITs through exchange-traded funds (ETFs). A few prominent ETFs that offer exposure to mREITs include:

Industry Overview

Quarterly Performance Data

Investing in Mortgage REITs

The REIT investment sector features a much larger variety of potential offerings than just equity REITs. Specifically, mortgage REITs allow investors to take advantage of mortgage-backed securities for passive income. Investors who are already heavily involved in equity REITs or traditional offerings who want to diversify their portfolios may want to take a look at this sector for new opportunities. 

The beauty of this sector is that the mortgages that finance single-family homes and commercial real estate are going to be necessary for as long as single-family homes and commercial properties are sold. That means mREITs have the potential to generate reliable investor returns for the long-term future. As with all investments, the risk of loss remains, but it’s also true that mREIT offerings have outperformed equity REITs overall. 

Frequently Asked Questions

REIT Alternatives

REITs provide a low-cost and simple way to invest in real estate. However, they aren’t the only option available to generate passive income through real estate with a low minimum investment.

Real estate crowdfunding offers investors the ability to decide which properties they want to invest while still enjoying passive income at a fraction of the cost of traditional methods of investing in real estate. Here are some of our favorite real estate crowdfunding platforms.

All Mortgage REITs

The post What are Mortgage REITs? by Eric McConnell appeared first on Benzinga. Visit Benzinga to get more great content like this.