In this low-yield climate, advisors and investors should go beyond municipal bonds and Treasuries in the hunt for steady income. Mortgage real estate investment trusts (mREITs) can help with that objective. The asset class is accessible via various exchange traded funds, including the VanEck Vectors Mortgage REIT Income ETF (NYSEArca: MORT).
Mortgage REITs have exhibited a negative correlation to interest rates changes, especially if the yield curve flattens. Many agencies use leverage to capitalize on the arbitrage spread between short- and long-term interest rates so companies can still make money in a rising rate environment, as long as long-term rates rise faster than the short-term rate or the yield curve steepens.
“One area that income investors may want to consider are mortgage REITs (mREITs), which we believe offer attractive income potential, historically yielding more than equity REITs and many other income-oriented securities,” writes VanEck analyst Coulter Regal. “mREITs generally invest in mortgage securities, loans, and operate in other areas of the mortgage and real estate ecosystem. Exposure to interest rate- and credit-sensitive assets in combination with leverage is what allows mREITs to offer attractive yields. However, this also subjects them to elevated risks that investors should consider when making an allocation.”
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Short-term borrowing costs also increased liquidity concerns in the mortgage market. Mortgage REITs would typically borrow at short-term interest rates and buy mortgages with higher long-term rates, profiting from the spread or difference between the two rates. As the short-term costs jumped, profits declined. Adding to the case for MORT are some vital tailwinds.
“Beyond cheap valuations, further bolstering attractiveness is friendly Fed action meant to stabilize and support the mortgage markets,” notes Regal. “The Fed has indicated that it will maintain easy policy going forward, which we believe will be supportive of the mREIT business model by keeping funding costs low. At the same time, the central bank is also supporting the industry through monthly purchases of mortgage-backed securities, worth billions of dollars, as part of its quantitative-easing program.”
Mortgage REITs do best during stable environments when both short-term interest rates and mortgage rates stay relatively constant.
“While mortgage REITs currently exhibit attractive characteristics, it is important to note that risks do exist with much of the real estate industry still in flux as shutdowns remain in place in certain areas of the country and the path towards economic recovery remains somewhat unclear,” says Regal.
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