How to Profit from Mortgage REITs?

Mortgage REITs are a type of real estate investment trust (REIT) that invests in mortgages or mortgage-backed securities (MBS). They are different from equity REITs, which own and operate properties. Mortgage REITs make money by borrowing funds at low interest rates and lending them at higher rates to homeowners or other borrowers. They also collect fees and dividends from the MBS they own.

Mortgage REITs can offer high yields to investors, as they pay out most of their income as dividends. However, they also come with high risks, as they are sensitive to changes in interest rates, credit quality, and market conditions. In this blog post, we will explain how mortgage REITs work, what are their advantages and disadvantages, and how to profit from them.

Introduction

In this article, we will explore the exciting world of Mortgage Real Estate Investment Trusts (REITs) and how investors can profit from them. A Mortgage REIT is a type of REIT that focuses on financing real estate by investing in mortgage-backed securities and other real estate-related loans. These investments provide an opportunity for individuals to earn substantial returns while diversifying their investment portfolio. So, let's dive in and discover how you can make the most of Mortgage REITs to grow your wealth.

Understanding Mortgage REITs

Mortgage REITs, also known as mREITs, are companies that finance real estate by investing in mortgages or mortgage-backed securities. These REITs do not own physical properties like traditional REITs; instead, they generate income from interest earned on mortgage loans. Investors in Mortgage REITs purchase shares of the company and, in turn, receive a portion of the income generated from the mortgage investments.

How Mortgage REITs Work?

mREITs work by borrowing money at lower interest rates and using these funds to invest in higher-yielding mortgage securities. The difference between the interest earned on the mortgage investments and the interest paid on the borrowed funds is the net interest spread, which is the primary source of income for Mortgage REITs. Additionally, Mortgage REITs may use leverage to enhance returns, but this also increases the risk.

Types of Mortgage REITs

There are two main types of mREITs: agency and non-agency.

Agency Mortgage REITs

Agency mREITs invest in mortgages or MBS that are guaranteed by government-sponsored enterprises (GSEs) such as Fannie Mae, Freddie Mac, or Ginnie Mae. These mortgages have a low risk of default, as the GSEs will cover any losses in case of borrower default. However, they also have lower interest rates and lower profit margins.

Agency mortgage REITs use leverage to boost their returns, meaning they borrow money to buy more MBS. This increases their exposure to interest rate risk, as any rise in borrowing costs can reduce their net interest income. Agency mortgage REITs also face prepayment risk, as borrowers can refinance their mortgages when interest rates fall, reducing the income stream from the MBS.

Some examples of agency mREITs are Annaly Capital Management (NLY), AGNC Investment Corp. (AGNC), and MFA Financial (MFA).

Non-Agency Mortgage REITs

Non-agency mortgage REITs invest in mortgages or MBS that are not guaranteed by GSEs. These mortgages have a higher risk of default, as there is no guarantee of repayment in case of borrower default. However, they also have higher interest rates and higher profit margins.

Non-agency mREITs use less leverage than agency mortgage REITs, as they have more capital at risk. They also face less prepayment risk, as borrowers are less likely to refinance their mortgages when interest rates fall. However, they face more credit risk, as any deterioration in the credit quality of the borrowers can lead to losses or impairments on the MBS.

Some examples of non-agency mREITs are New Residential Investment Corp. (NRZ), Starwood Property Trust (STWD), and Chimera Investment Corp. (CIM).

Strategies for Profiting from Mortgage REITs

To profit from Mortgage REITs, investors can employ various strategies to optimize their returns and manage risks effectively:

Diversify Your Investments

Diversification is a fundamental strategy to reduce risk in any investment portfolio. Consider investing in a mix of Mortgage REITs with different investment styles and geographic focuses. This approach can help spread risk and potentially improve overall returns.

Analyze the REIT’s Investment Approach

Before investing in a Mortgage REIT, carefully analyze its investment approach, such as the types of mortgage-backed securities it invests in, the average credit quality of the loans, and the interest rate sensitivity. Understanding these factors can help you assess the REIT's risk profile and alignment with your investment goals.

Monitor Interest Rate Trends

Interest rates play a significant role in the performance of Mortgage REITs. Keep a close eye on interest rate trends and be prepared to adjust your investment strategy accordingly. For example, consider reducing exposure to mREITs during periods of rising interest rates.

Assess the Management Team

The expertise and track record of the management team are crucial indicators of a mREIT's potential success. Research the management team's qualifications, experience, and past performance to make informed investment decisions.

Reinvest Dividends

If you're in it for the long haul, consider reinvesting the dividends received from Mortgage REITs. Reinvestment can compound your returns over time and help accelerate the growth of your investment.

Advantages and Disadvantages of Investing in Mortgage REITs

mREITs have some advantages and disadvantages for investors, depending on their risk appetite, income needs, and market outlook.

Advantages

• High Yield: Mortgage REITs typically pay out most of their income as dividends, which can be attractive for income-seeking investors. The average dividend yield for mREITs was 8.9% as of June 30, 2021, according to Nareit.
• Diversification: Mortgage REITs can provide diversification benefits for investors, as they have a low correlation with other asset classes such as stocks and bonds. This means they can reduce the overall volatility and risk of a portfolio.
• Liquidity: Mortgage REITs trade on public exchanges like stocks, which means they are easy to buy and sell. They also have transparent financial statements and disclosures, which can help investors evaluate their performance and risks.

Disadvantages

• High Risk: Mortgage REITs are subject to various risks that can affect their profitability and sustainability. These include interest rate risk, credit risk, prepayment risk, liquidity risk, leverage risk, regulatory risk, and market risk. Any adverse change in these factors can result in losses or dividend cuts for investors.
• High Volatility: Mortgage REITs tend to have high price volatility due to their sensitivity to market conditions and investor sentiment. They can experience large swings in value depending on the direction and magnitude of interest rate movements and credit spreads.
• High Taxes: Mortgage REIT dividends are generally taxed as ordinary income rather than qualified dividends, which means they are subject to higher tax rates than other types of dividends. Investors may be able to reduce their tax burden by holding mREITs in tax-advantaged accounts such as IRAs or Roth IRAs.

Best Mortgage REITs 2023

If you are looking for the best U.S. mortgage REITs to buy for 2023, you might want to consider these four candidates that have outperformed the sector so far this year. They are:

• TPG RE Finance Trust Inc. (TRTX): This mREIT is a balance sheet lender that provides first mortgage loans to commercial real estate owners and operators across the U.S. It has a portfolio of $5.4 billion and a dividend yield of 11.05%. It reported strong earnings in the fourth quarter of 2022, beating analysts' expectations by $0.29 per share.
• Great Ajax Corp. (AJX): This mREIT invests in mortgage loans secured by single-family, multifamily, and commercial properties, as well as foreclosure properties that it rents or sells with financing. It has a market cap of $199.39 million and a dividend yield of 12.39%. It will announce its fourth-quarter and year-end 2022 results on March 2, 2023.
• Brightspire Capital Inc. (BRSP): This mREIT is a diversified lender that offers commercial real estate loans, mezzanine loans, and other types of financing. It has a portfolio of $4.8 billion and a dividend yield of 9.94%. It reported positive earnings in the fourth quarter of 2022, beating analysts' estimates by $0.04 per share.
• New Residential Investment Corp. (NRZ): This mREIT invests in residential mortgage loans, mortgage servicing rights, mortgage-backed securities, and other related assets. It has a portfolio of $23 billion and a dividend yield of 10.42%. It reported solid earnings in the fourth quarter of 2022, beating analysts' forecasts by $0.01 per share.

These four mREITs have shown resilience and growth in a challenging environment for the sector, and they could continue to deliver strong returns for investors in 2023.

Conclusion

Investing in Mortgage REITs can be a lucrative way to earn passive income and diversify your investment portfolio. By understanding how Mortgage REITs work, their advantages, risks, and employing strategic investment approaches, you can position yourself for potential success.

Remember, as with any investment, thorough research and careful consideration of your financial goals and risk tolerance are crucial to making informed decisions.

Also Read: A Closer Look at the Fees and Expenses of BEST Mutual Funds

Disclaimer

This blog post is for informational purposes only and does not constitute investment advice or recommendation. You should consult your financial advisor before making any investment decisions.