The Ultimate Guide to Mortgage REIT Investing

By: ,

why do reits have high dividend payout ratios

The ultimate guide to mortgage REIT investing is intended to help those seeking to profit from a unique kind of equity real estate investment trusts (REIT).

Many investors likely are familiar with REITs but far fewer individuals may be acquainted with their younger cousins: mortgage REITs (mREITs). Indeed, mREITs first emerged in the mid-1980s.

As one may surmise, mREITs are a type of REIT that invests primarily in mortgages and other types of real estate debt. While traditional equity REITs generate income through purchasing, selling and renting physical properties, mREITs achieve returns by investing in mortgage-backed securities (MBS), commercial mortgage loans and other real estate debt instruments.


Investors should keep in mind that mREITs typically are more volatile than equity REITs but can provide higher dividend yields. Like equity REITs, mREITs can be found on major exchanges. 

The Ultimate Guide to Mortgage REIT Investing: Agency vs. Non-Agency

Further, mREITs are split into two categories: agency and non-agency. Agency REITs only invest in federally insured mortgages, typically through government-sponsored entities such as Fannie Mae and Freddie Mac. Non-agency REITs have no such restrictions, opening investors to higher risk and potentially higher returns.

REITs and mREITs offer similar portfolio diversification benefits. REITs possess a low correlation with the stock market, reducing potential losses when equities perform poorly. Plus, REITs are considered safer investments than many other securities, as they have an underlying tangible asset (real estate) as collateral. Finally, by law, REITs must distribute at least 90% of their taxable income to shareholders annually, providing investors with a consistent cash stream.

Despite pursuing two different investment strategies, mREITs are subject to many of the same risks as equity REITs. mREITs have historically provided high dividend yields to investors due to their specialized focus on real estate debt. However, their performance can be heavily affected by interest rate fluctuations and changes in the real estate market.

The Ultimate Guide to Mortgage REIT Investing: Performance

The COVID-19 pandemic initially shattered the real estate market, leading to an 18.8% drop in the FTSE Nareit mREIT index in 2020. However, the mREIT index jumped by 15.7% in 2021 as the real estate market rebounded following the federal government’s efforts to slash interest rates and introduce stimulus packages.

Interest rates play a huge factor in the performance of mREITs. When interest rates rise, the value of mREIT holdings can decrease. Newly issued mortgages offer higher interest payments, causing the value of existing mortgages to fall. Other debt instruments like bonds also experience the same interest rate risk. The opposite is true when interest rates fall.

In 2018, the Federal Reserve raised interest rates four times. The Nareit mREIT index declined by 2.5% in the same year. In contrast, the Federal Reserve slashed interest rates three times a year later, helping the mREIT index skyrocket by 21.3% in 2019. Although mREITs perform the best during periods of low interest rates and volatility, they serve as a better hedge against interest rate risk than equity REITs, typically outperforming them during periods of rising interest.


The Ultimate Guide to Mortgage REIT Investing: Risks

REITs are also subject to credit, prepayment and liquidity risks. Credit risk is the default risk of borrowers. Prepayment risk arises from borrowers paying off their mortgages early, reducing the amount of interest earned by lenders. Liquidity risk is being unable to sell investments quickly enough to meet cash flow needs. Credit, prepayment and liquidity risks are typically less significant than interest rate concerns and real estate fluctuations. However, they can lead to significant issues when they do arise, like in 2008.

Unlike equity REITs, mREITs also possess rollover risk. mREITs, typically residential mREITs, may fund the purchase of their long-term mortgages through short-term debt. If so, trusts must refinance their short-term debt at favorable rates to consistently generate returns.

mREITs are more volatile than equity REITs but can provide higher dividends in return. Investors looking to increase their diversification while maintaining higher returns may benefit from adding mREITs to their portfolios.


Want more? Read our related articles:

The Ultimate Guide to Investing in REITs

Why Do REITs Have High Dividend Payout Ratios?

How Risky are REITs? 

The 13 Types of REIT Stocks and How to Invest in Them 

Investing in REITs: Pros and Cons 

What is a REIT?

Dividend increases and dividend decreases, new dividend announcements, dividend suspensions and other dividend changes occur daily. To make sure you don’t miss any important announcements, sign up for our E-mail Alerts. Let us do the hard work of gathering the data and sending the relevant information directly to your inbox.


Related Posts:

Capison Pang

Connect with Capison Pang

Capison Pang
Capison Pang is an investment writing intern with Eagle Publications, covering various topics for and Pang previously interned with the U.S. Securities & Exchange Commission, BMO Capital Markets and Rocket Mortgage. He is currently a senior at Indiana University-Bloomington, pursuing a bachelor's in finance with a mathematics minor. He is on schedule to graduate in early May 2023.
Search Dividend Investor