Mortgage REITs operate like “virtual banks,” borrowing cheaply for the short-term and using the proceeds to buy long-dated mortgages. The difference between the two is the “spread,” which varies based on the term structure of interest rates.
Rising bond yields have wrecked the book value of these REITs’ mortgage holdings and have prompted investors to dump the securities en masse. But going forward, a steeper yield curve is actually good, as it increases the spread between the borrowing rate and the lending rate.
The question you have to ask yourself as a potential investor is this: Has the curve finished steepening, or do we have a ways to go?
If believe, as I do, that the hike in Treasury bond yields is a short-term blip and not a major regime shift, then mortgage REITs as a sector make sense. Many of the larger names — such as Annaly Capital Management (NLY) — now sell for well below book value.
But I should be clear here: While equity REITs are solid buy-and-hold investments for investors who want exposure to real, income-producing assets, mREITs most assuredly are not. They are closer to publically traded hedge funds and are nothing more than highly leveraged paper-shuffling vehicles.
Mortgage REITs should be viewed as a trade, not a long-term investment.
On the ETF front, there are two mortgage REIT funds of note: the Market Vectors Mortgage REIT ETF (MORT) and the iShares FTSE NAREIT Mortgage Plus Index ETF (REM), which currently yield 9.25% and 11.15%, respectively. But please note that mortgage REIT dividends are fair less consistent than equity REIT dividends.
Note: I left out many REIT ETFs either due to lack of assets under management and liquidity concerns or because, in my estimation, they added no noteworthy new exposure that wasn’t already covered by another ETF.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, Sizemore Capital was long VNQ. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.