Unsatisfied with your low, single-digit dividends and bond yields? Investors can squeeze out more income with mortgage-backed real estate investment trusts and exchange traded funds, but you will have to be comfortable with the potential risks.
Mortgage REITs are leveraged investment companies that borrow to buy mortgages and other real-estate related securities, writes Kathy Kristof for Kiplinger. [Mortgage REIT ETF Yielding 12% Starts Year Strong]
If the companies buy “nonagency” loans — debt that is not backed by agencies like the Government National Mortgage Association or the Federal National Mortgage Association — then investors are subject to defaults and potential losses. On the flip side, the added risk translates to a higher yield premium.
Investors who are considering these investments believe that both the housing market and the economy are seeing healthy growth.
“This is a great environment to be a mortgage investor,” Jason Stewart, an analyst with Compass Point Research, said in the article. Stewart is leaning toward nonagency debt, despite the risks, as the investments offer greater rates and real estate prices are rising.
Mortgage REITs have gained 11.7% so far this year and come with an average 11.5% yield.
However, interest rate risk poses a potential problems. A higher interest rate translate to lower capital returns. Additionally, higher short-term interest rates would also increase mortgage REITs’ cost of funds and could cause some to lower dividends.
“You have to keep an eye on the Fed,” Merrill Ross, REIT analyst with Wunderlich Securities, said in the article. “As short-term interest rates start to rise, it’s a good time to get out of these stocks.”
The iShares FTSE NAREIT Mortgage REITs Index Fund (NYSEArca: REM) tracks U.S. residential and commercial REITs. Its top two holdings, Annaly Capital Management (NYSE: NLY) and American Capital Agency (NYSE: AGNC), make up 36.8% of the overall portfolio while other the rest of the holdings are less than 5%. REM has a 0.48% expense ratio and a 11.24% 12-month yield. The fund is up 26.2% over the past year.
The Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) is a similar fund, except its allocation to NLY and AGNC makes up 29.9% of the overall portfolio. MORT comes with a 0.40% expense ratio and a 10.76% 12-month yield. The ETF is up 28.0% over the last year.
iShares FTSE NAREIT Mortgage REITs Index Fund
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.