The Basics of Investing in Mortgage REITs

Investing in mortgage REITs (mREITs) can be a lucrative opportunity for those seeking to:

• Diversify their investment portfolios
• Find a long-term investment
• Establish a bulwark against inflation or stock market volatility

Whether you’re new to real estate investing or looking to expand your investment strategy, understanding the fundamentals of mortgage REITs is essential for building a successful investment portfolio.

What are Mortgage REITs?

Real Estate Investment Trusts (REITs) are companies that finance, own, and operate income-producing real estate.

Their big advantage is that they allow individuals to invest in large-scale, income-producing real estate without actually having to buy, manage, or finance any properties themselves.

Different types of REITs

There are two main types of REITs:

1. Equity REITs, which primarily invest in and own properties
2. Mortgage REITs are entities that finance income-generating real estate—by acquiring or initiating mortgages and securities backed by mortgages

Mortgage REITs generate income through the interest that is earned on their investments in real estate mortgages.

Some mREITs focus on residential mortgages, while others specialize in commercial mortgages. These different types of mortgage REITs offer varying levels of risk and return potential, catering to different investment preferences and strategies.

Benefits of investing in mortgage REITs

• High-yield dividends: Investing in mortgage REITs offers the potential for high dividend yields, which can be especially attractive for income-seeking investors
• Distribution: Mortgage REITs have a requirement to distribute at least 90% of their taxable income to their shareholders in the form of dividends
• Mitigated risk: Investors can spread their risk across different asset classes—which can help reduce overall portfolio volatility and potentially enhance long-term returns.
• Increasing value: Because mortgage REITs invest in mortgage-backed securities (MBS), their value can increase as the underlying mortgages are paid down or as interest rates decrease, leading to potential capital gains for investors.

How to invest in mortgage REITs

Investing in mREITs involves various methods. One common approach is the direct purchase of mREIT shares—enabling you to buy direct ownership of shares of a specific mortgage REIT company through a brokerage account.

When considering this option, it’s crucial to conduct thorough research on the specific mortgage REITs, analyzing factors such as their:

• Portfolio composition
• Management team
• Historical performance
• Dividend payout history

Additionally, it’s highly advisable to stay informed about interest rate movements and economic conditions, as they can significantly impact the performance of mortgage REITs.

Investing in mortgage REIT ETFs or mutual funds

For those seeking diversification within the mortgage REIT sector, investing in mortgage REIT exchange-traded funds (ETFs) or mutual funds can also work.

These investment vehicles provide exposure to a ‘basket’ of mortgage REITs, offering diversification benefits while mitigating company-specific risks.

However, it’s essential to assess the expense ratios, historical performance, and underlying holdings of the ETFs or mutual funds before making investment decisions.

Private mortgage REITs

Private mortgage REITs present an alternative investment avenue within the mREIT space.

These entities typically provide access to real estate debt investments without having to resort to using public exchanges. This offers the potential for attractive risk-adjusted returns.

Investing in private mortgage REITs often involves working with experienced fund managers who manage mortgage lending and real estate investments, such as Marquee Funding Group.

They can also help conduct thorough due diligence and increase your understanding of an investment strategy and underwriting standards, as well as the nature of the underlying real estate assets.

Risks Associated with Mortgage REITs

Mortgage REITs often result in attractive dividends. But that doesn’t mean you should ignore the potential risks associated with investing in them.

Interest rate risk

Fluctuating interest rates mean the value of the underlying mortgages held by the REITs might be impacted. Interest rates rise—the value of the mortgages may decrease. This could diminish the REITs’ overall returns.

However, the opposite is also true. When interest rates fall, the value of the mortgages can increase—positively affecting your REITs’ returns.

Credit risk

‘Credit risk’ relates to the possibility of default by borrowers on the mortgages held by the REITs. Significant numbers of borrowers defaulting on their loans might lead to a decrease in the overall value of the mortgage portfolio and, in turn, impact the REITs’ performance.

Prepayment risk

Prepayment risk stems from the potential for borrowers to pay their mortgages earlier than planned—a particular risk when interest rates are low. Refinancing or selling their properties can result in a reduction in expected interest income, impacting returns.

Tax considerations for mortgage REIT investors

• Pass-through taxation: Income generated by the REIT is passed through to the investors, who are then taxed at their individual tax rates. Unlike regular corporations, which face double taxation at the corporate and individual levels, mREITs provide the advantage of avoiding entity-level taxation.
• Qualified dividend income: Investors in mortgage REITs also benefit from a classification of the dividends as qualified dividend income—potentially leading to lower tax rates for investors and aligning with the tax treatment of long-term capital gains.
• Unrelated business taxable income: REIT dividends are typically considered ordinary income and not subject to UBTI. However, certain activities, such as investing in mortgage REITs using leverage or through a retirement account, may trigger UBTI.

Ultimately, understanding the tax considerations for investing in mortgage REITs is essential for maximizing investment returns and ensuring compliance with tax regulations. Professional advice, especially for your personal tax situation, is always recommended.

Is a private mREIT right for your investment situation?

Investing in mREITs can be a lucrative opportunity for diversifying a real estate investment portfolio.

Understanding the basics of mREITs, along with the risks and rewards, makes for better-informed investment decisions and greater chances of success.

It’s hard to overlook the potential for high dividends and the ability to access real estate markets without having to own the physical properties themselves.

Private mREITs offer an attractive investment avenue for those seeking passive income and portfolio growth.

As experts in investment and real estate, Marquee Funding Group is committed to providing valuable insights and opportunities for investors looking to capitalize on the benefits of mortgage REITs.