Mortgage REITs, or mREITs, have historically exhibited high dividend yields, making them an appealing segment of real estate for investors comfortable with risk.
For example, the VanEck Vectors Mortgage REIT Income ETF (MORT) has currently offers a 6.85% yield, the second-highest of any real estate ETF.
The iShares Mortgage Real Estate ETF (REM), meanwhile, offers a 6.08% dividend yield—the fourth highest of any real estate ETF.
Why Are mREIT Dividends So High?
A key factor in why mREIT dividends are so high is that all REITs are legally required to pay out a minimum of 90% of their profits as non-qualified dividends. Some even manage to pay out over 100%, since companies can write off real estate investments as depreciation.
Even with that in mind, the mortgage REIT yield soars over the equity REIT due to the different natures of their business models.
Equity REITs own property, thereby generate cashflow from rent payments.
However, mREITs purchase real estate debt—namely, mortgages and mortgage-backed securities—then use the spread between borrowing and lending to generate profit.
That is to say, mREITs don’t actually hold any property, just the debt based on that property.
The Two Kinds of mREITs
There are two kinds of mREITs: residential and commercial. Residential mREITs buy lower credit risk real estate debt: home mortgage-backed securities that are insured against default. (Because this particular class of mREIT holds agency securities backed by the federal government, residential mREITs carry virtually no risk of default.)
Yet, there are other risks. Residential mREITs need to take on higher leverage and hedge against changes in interest rates. Also, there is always the possibility of prepayment if the homeowner refinances or pays off their original mortgage before the interest has had the time to accrue.
Commercial mREITs, however, invest in or originate in commercial mortgages. These aren’t government-backed, so the risk is higher. However, these types of loans tend to be higher yielding, meaning commercial mREITs can operate with far lower leverage levels. Commercial real estate is also more stable than residential real estate, particularly if (and when) interest rates rise.
Many real estate ETFs have partial exposure to mortgage REITs, but there are two that focus entirely on these high dividend-paying assets: MORT and REM.
Both funds hold mREITs that have exhibited strong dividend yields over time, including Annaly Capital Management (NLY), which has a dividend yield of 9.47%; AGNC Investment (AGNC), with a yield of 7.8%; and Starwood Property Trust (STWD), with a yield 7.7%, according to Marketbeat.
For more news, information, and strategy, visit the Dividend Channel.