A Complete Guide To Mortgage REITs (mREITs)
Sarah Sharkey3-minute read
November 14, 2023
Mortgage REITs provide liquidity for the real estate industry and an opportunity for investors. Want to find out more about these unique funds? Read on to learn more about how mREITs work and the pros and cons of investing in them.
What Is A Mortgage REIT?
Mortgage REITs, or mREITs, are investments in purchased or originated mortgages and mortgage-backed securities (MBS) that earn income from the interest paid on those assets. mREITs are essential in providing liquidity in the real estate market.
Mortgage REITs, or real estate investment trusts, provide a critical function in the economy through the facilitation of the housing market. Without mREITs, there would be considerably less liquidity in the industry which would make it more difficult for borrowers to find financing opportunities.
Mortgage investors can back both commercial mortgage and residential mortgage opportunities. The makeup of an mREIT will vary based on the goals of the investors. An investor can purchase mortgage REITs as they would any other public stock or as part of an ETF or mutual fund.
Mortgage REITs Vs. Equity REITs
An equity REIT is the most common type of REIT. An equity REIT owns and operates the properties in its holdings. With that, an equity REIT often generates revenue through rental income. A mortgage REIT investment generates revenue through interest income from mortgages and mortgage-backed securities.
Equity REITs are able to provide a more stable income. But mortgage REITs can often offer higher dividend yields, especially with rising interest rates.
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Should You Invest In Mortgage REIT Stocks?
A mortgage REIT could be a sound addition to your investment portfolio, as they offer competitive total returns. But you should take some time to review the pros and cons of this investment before making a final decision.
Benefits Of Investing In Mortgage REITs
First, let’s take a look at the benefits associated with investing in a mortgage REIT.
- 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 a REIT’s income. This can help ensure that your funds are being well taken care of.
- Contributing to the industry: Liquidity and credit produced by mortgage REITs are used to fund mortgage loans for home buyers. This can allow the industry to continue functioning well.
Additionally, you’ll need to consider your personal investment goals. A mortgage REIT could be a good choice if you’re looking for an investment with the potential for relatively high dividend yields.
Risks Of Investing In Mortgage REITs
As with all financial products, some drawbacks need to be taken into account. Here’s a closer look:
- Interest rate risk: Interest rates are known to fluctuate over time. With fluctuations in market interest rates, the value of a mortgage REIT will be affected. After all, the ability to make this venture possible is through interest rates. It makes sense that a fluctuating interest rate would dramatically impact the value of a mortgage REIT.
- Prepayment risk: Mortgage REITs make decisions based on the terms set forth in a mortgage. But something to be considered is that a borrower can refinance their loan for better terms or pay off their mortgage ahead of schedule. In either scenario, the investors would lose out on interest payments and be forced to reinvest. That could lead to a reinvestment period in a higher or lower interest rate environment.
- 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.
- Rollover risk: Residential mREITs typically have long-term mortgages and long-term mortgage-backed securities but are bought with short-term debt. These short-term debts often have lower interest rates than the long-term rates, so the tradeoff creates rollover risk.
Mortgage REITs have risks associated with them, just like all other investments. Consider if the risks fit within your tolerance.
The Bottom Line
A mortgage REIT could be a good investment opportunity. Luckily, it’s not difficult to invest in mortgage REIT stocks through most brokerage platforms.
Considering more ways to invest in real estate? Learn more about investing in commercial real estate with our guide to commercial REITs.
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