When CDs yield less than 2% for a 5-year maturity period, 15% dividends look like a gift from the heavens. Mortgage REITs seemingly deliver huge returns when no other fixed-income or equity investment can do the same.
So what’s the special sauce? Why can mortgage REITs afford to pay huge dividends to their investors?
There are a few distinctions that differentiate mortgage REITs from other investments:
There are two types of mortgage – agency and non-agency REITs. Agency REITs invest only in mortgages that are secured by US Government agencies Fannie Mae and Freddie Mac. Non-agency REITs invest in mortgages of every flavour, typically generating higher returns because there is no guarantee on the quality of the debt or guarantee of future cash receipts.
Agency mortgages are perceived to be as risky as the US government’s US Treasury issuances. Following the US financial crisis, the United States government agreed to back all debts by Fannie and Freddie, making the risk of agency mortgages on par with the risk embedded in US Treasury securities. As US Treasuries are “risk-free” in the sense that the US Treasury can always print more money, so too are agency mortgages – at least for as long as the US government agrees to back the mortgage debt.
A mortgage is on every investor’s radar for their larger than average yields, but they do require some real thinking about the future of interest rates. Always read the annual and quarterly report for any REIT in which you would think about investing.
In particular, look for:
Ideally, any REIT would have limited rate sensitivity (especially if you expect rates to go up over time) and would maximize potential rewards with risk by moderating leverage.
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