Issues to Consider With mREIT ETFs in 2015

Buoyed by tumbling 10-year Treasury yields, mortgage REIT exchange trade funds have been solid though not spectacular performers this year.

The iShares Mortgage Real Estate Capped ETF (NYSEArca: REM) and the Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) are up 7.6% and 11.9%, respectively, but that does not obfuscate the fact that rising interest rates are a significant headwind for REIT ETFs of all stripes, including MORT and REM. [Falling Rates Lift REIT ETFs]

When Treasury yields surged last year, MORT posted a gain of just 1.1% while REM slid 2.7%, underscoring the inverse relationship these ETFs have to Treasury yields. Conventional wisdom dictates that higher interest rates diminish the chances that homeowners will refinance their mortgage rates. Additionally, 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.

MORT and REM still sport tempting 30-day SEC yields of 10.42% and 9.24%, respectively, but challenges remain.

“While recent yields on mortgage REITs have been attractive, they face two significant challenges in the near future. First, several components of Basel III will go into effect in January 2015. Among these are higher capital standards. These could impact the REPO market through higher costs and reduced liquidity. The REPO market is an important source of capital for mortgage REITs, which means that their funding costs could rise,” according to a post by Victor Calanog and Ryan Severino, Heads of Economics and Research, Reis, on the Market Vectors blog.