The stabilizing interest rates have helped high-yield, mortgage-backed real estate investment trust exchange funds rebound, but investors should be aware that a tightening yield curve could weigh on the assets.
The Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) has increased 10.9% year-to-date while the iShares Mortgage Real Estate Capped ETF (NYSEArca: REM) gained 11.6%.
Investors dumped mREITs last year when yields on benchmark 10-year bonds jumped over 100 basis points in response to speculation on Fed tapering. The higher interest rates diminish the chances that homeowners will refinance their mortgage rates. Consequently, the securities have declined in value to reflect the rising risk of holding high duration bonds over a longer period.
Moreover, many mortgage REITs did not anticipate the sharp spike in interest rates and the result was a rash of dividend cuts from REM and MORT holdings. Nevertheless, the two ETFs still offer robust yields, with REM showing a 14.61% 12-month yield and MORT sporting a 13.27% 12-month yield.
Benchmark 10-yaer Treasury yields stabilized this year, falling 25 basis points as investors turned back to conservative bond plays, bolstering investment interest for high-yield mREITs.
Now, mREIT investors may want to keep an eye on rising short-term rates. REITs generate cash by profiting on the spread between long-term rates and short-term rates. The companies borrow money on short-term rates and use the money to purchase long-term bonds, so they generate larger yields on wider spreads.
However, the spread between five-year and 30-year yields have narrowed to their tightest range since 2009 on speculation that the Fed will end stimulus and raise rates sooner than expected, Bloomberg reports.
“We have a market that is increasingly buying in to the prospect of sooner-than-expected rate hikes,” Adrian Miller, director of fixed-income strategies at GMP Securities LLC, said in the article. “We’ve seen a large flattening, especially the 5s-30s curve, and that flattening represents a recalibration of the market’s expectations to the growing hawkishness of the Fed.”
iShares Mortgage Real Estate Capped ETF
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.