A complete guide to mortgage REITs

Becoming a real estate investor doesn’t have to mean managing rental properties. Mortgage real estate investment trusts (mREITs) allow investors to invest in the real estate market without buying an investment property themselves. For many new investors, this can feel like a more approachable option for wading into real estate.

A real estate investment trust (REIT) simplifies real estate investing, and your initial financial commitment may be very small. Here’s a closer look at how mREITs work and several important pros and cons to consider.

What are REITs?

A REIT is a company that manages real estate on behalf of its investors, paying a significant portion of its income as dividends. Many REITs are public companies traded on the stock market. You should do some research before investing and carefully consider the pros and cons of any investment.

Within the REIT category, you’ll find a wide variety of investment opportunities. These can include REITs focused on residential, commercial, or highly specialized areas, such as retirement homes, resort hotels, or golf courses.

As with any other investment, savvy investors take time to learn more about the potential returns, risks, and how it may fit into their long-term investment strategy before investing. If you have doubts about the risk, it may be best to work with a licensed finance professional.

What is a mortgage REIT?

A mortgage REIT invests in mortgages and mortgage-backed securities (MBS). These companies, sometimes effectively operating like an investment fund, buy large numbers of mortgages or MBSs to earn an income from the interest paid on those loans.

Mortgage investors selling mortgages play an essential role in the real estate marketplace. They also buy and securitize loans originated by other lenders, freeing up cash for new mortgages. That cycle of originating and selling mortgages is a fundamental part of the homeownership economy.

If you’re looking to invest in mortgage REITs, you can find them traded on major stock exchanges, such as the New York Stock Exchange and Nasdaq. Mortgage REITs can play a role in building a diversified portfolio spread across multiple asset classes.

What are mortgage-backed securities?

Mortgage-backed securities are an investment in which a large collection of home loans is combined to create a bond, which investors can buy and sell on secondary markets or hold to maturity.

Government-affiliated entities like Fannie Mae and Freddie Mac commonly buy mortgages from the originating lender, package them into an MBS, and sell them to investors, including mREITs.

Equity REITs vs. mortgage REITs

An equity REIT is the most common type of REIT. An equity REIT owns and operates the properties in its holdings, such as a large number of apartment buildings or self-storage centers. With that, an equity REIT often generates revenue through rental income.

A mortgage REIT generates income through interest from mortgages and mortgage-backed securities. Equity REITs sometimes provide a more stable income, while mortgage REITs can often offer higher dividend yields, particularly with rising interest rates.

Benefits of investing in mortgage REITs

Mortgage REITs can be beneficial to investors, lenders, and borrowers alike. Each plays an important role in the real estate ecosystem. Here are some benefits investors seek when funneling their funds into mortgage REITs:

• Diversification. Investing in mortgage REITs and other real estate-based investments can help diversify your real estate portfolio.
• No home maintenance. You can invest in the real estate industry without purchasing any physical property. With that, you won’t have to worry about many of the usual headaches that owning rental property requires you to deal with, such as leaky roofs and problem tenants.
• Protected funds. The IRS requires that shareholders receive at least 90% of an REIT’s income. This can help ensure that your funds are being well taken care of.
• Liquidity. Unlike physical properties, which can take months to sell, you may be able to sell a REIT with a near-instant sale in your stock market account.

Another general benefit is that mortgage REITs help fund mortgage loans for home buyers by adding capital to the industry. Liquidity and credit produced by mortgage REITs allow the industry to continue functioning effectively.

Risks of investing in mortgage REITs

While mortgage REIT investing can be beneficial, it’s not without risks. Understanding how your investment could underperform or lead to losses can help you make a more educated investment decision.

Mortgage REITs can be risky for the following reasons:

• Interest rate risk. Interest rates generally fluctuate over time, but no one can predict them. When market interest rates rise and fall, the value of a mortgage REIT is affected. When market rates rise, bond prices tend to fall, as investors can earn better rates elsewhere. Conversely, when rates fall, investors may be willing to pay a premium for a higher return.
• Prepayment risk. Mortgage REITs make decisions based on the terms outlined in a mortgage. But if a home buyer refinances their loan for better terms or pays off their loan early, the investors could lose out on planned interest payments.
• Credit risk. If a mortgage is not backed by a federal agency, such as Fannie Mae or Freddie Mac, it may present a higher credit risk to the investors if the borrower defaults. If a borrower defaults (stops paying their loan as agreed), the investment will provide lower-than-expected returns.
• Rollover risk. Residential mortgage REITs often borrow money cheaply for short periods to buy long-term mortgages. That means the REIT may have to borrow again in the short term to continue holding the long-term loans, risking higher costs when they need to renew (roll over) at the end of each short-term period.

While all investments carry some level of risk, researching each mortgage REIT thoroughly before making a purchase can help you manage your risk exposure and keep your investments aligned with your financial goals.

FAQ

While you’re evaluating mortgage REITs as an investment, consider these common questions about them.

Should you invest in an equity REIT or a mortgage REIT?

While equity REITs earn income from owning physical properties, mortgage REITs generate returns from the interest on mortgages. This means that mortgage REITs can be riskier but can offer higher yields.

How often do mortgage REITs pay dividends?

Every mortgage REIT can pay dividends on the schedule it chooses. Most pay dividends quarterly, though some pay monthly or semiannually. A portfolio of monthly dividend REITs can help investors build a predictable monthly cash flow.

The bottom line

If you want to invest in a group of properties at once, a REIT may be the right choice. To invest in a bundle of mortgages, a mortgage REIT could be the best tool. Either can make sense for a wide range of investors, depending on their goals and circumstances.

And if you want to invest in individual properties directly, you’re able to do that as well. If you want to buy an investment property and need a mortgage, you can start the process here with Rocket Mortgage® to learn more.