Mortgage Real Estate Investment Trusts (mortgage REITS or mREITs) play a unique role in many investment portfolios: an opportunity to participate in the mortgage market without directly owning property.
Traditional REITs invest in physical real estate. Mortgage REITs, however, directly target the financial instruments are the nucleus of the real estate deal.
But what exactly do mortgage REITs invest in, and how do they generate returns for their shareholders?
In this article, we’ll examine the diverse portfolio of mortgage REITs, exploring their types of investments and strategies for navigating the complex world of real estate financing.
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What is a mortgage REIT?
Mortgage REITs are companies primarily concentrating on mortgage-backed securities (MBS) and real estate-related assets.
This shouldn’t be confused with equity REITs, which own and manage properties and have to contend with all the headaches associated with property management.
How do mortgage REITs work?
Mortgage REITs generate income via the interest earned on their investments in mortgages. Once investors grasp this distinction, the risk and return profile of mREITs can be clarified.
What does a mortgage REIT invest in?
Let’s look at a more detailed listing of the investments of mortgage REITs
Residential mortgage-backed securities (RMBS)
RMBS is a cornerstone investment for many mREITs. These securities are pools of residential mortgages that have been securitized and sold to investors.
The cash flows from these mortgages, including principal and interest payments, are passed through to the holders of the securities.
RMBS can be either agency-backed—guaranteed by GSEs like Fannie Mae or Freddie Mac—or non-agency, which do not carry such guarantees and therefore come with higher risk and potentially higher returns.
Commercial mortgage-backed securities (CMBS)
CMBS is similar to RMBS but is backed by commercial properties, such as office buildings, shopping centers, and hotels.
These securities tend to be more complex and can offer higher yields due to the larger size and longer duration of the underlying commercial real estate loans.
Investing in CMBS allows mREITs to diversify their portfolios and tap into the commercial real estate market’s income streams.
Whole loans
In addition to mortgage-backed securities, some mREITs invest in whole loans, that are individual mortgage loans that have not been securitized.
Whole loans can provide a more direct form of investment in the real estate market and offer the potential for higher returns, as mREITs can negotiate terms directly with borrowers.
This investment requires more active management and carries different risks than investing in securitized products.
Other real estate-related assets
Beyond RMBS, CMBS, and whole loans, mREITs may invest in other real estate-related assets.
These can include:
- Mortgage servicing rights (MSRs), which are the rights to service and collect payments on mortgage loans
- Real estate debt instruments like mezzanine loans and preferred equity
These additional investments can enhance an mREIT’s yield and diversify its portfolio.
Investment strategies for mortgage REITs
Here are the top ways an investment company that deals with mortgage REITs can turn their assets into profit and mitigate the inherent risks specific to these investments.
Leveraged investing
One of the defining characteristics of mREITs is their use of leverage to amplify returns.
By borrowing funds to invest in mortgage assets, mREITs can enhance their income potential.
However, this strategy also increases risk, as mREITs must manage the cost of borrowing and potential changes in interest rates that could impact their profitability.
Interest rate risk management
Managing interest rate risk is a central aspect of most mREIT investment strategies.
Since mREITs borrow short-term funds to invest in long-term mortgage assets, they are exposed to the risk of changing interest rates, which can increase their borrowing costs and compress margins.
However, there are ways that mREITs can mitigate these risks, often by using hedging strategies such as interest rate swaps, caps, and other derivatives to protect portfolios.
Credit risk management
Credit risk is another aspect that needs attention, particularly when investing in non-agency RMBS and CMBS.
Borrowers could default on their mortgage payments, which can impact the cash flows and value of the underlying securities.
Conducting thorough due diligence and using credit enhancement strategies are two of the best ways to manage this risk.
10 benefits of investing in mortgage REITs
There are several benefits to investing in private mortgage REITs:
- Potential for higher returns: Private mortgage REITs may offer higher yields compared to traditional fixed-income investments, especially in a rising interest rate environment
- Consistent monthly income: Investors typically receive monthly or quarterly dividend payments, providing a steady stream of passive cash flow
- Real estate security: The investments are backed by tangible real estate assets, offering an added layer of security compared to some other investments
- Improved liquidity: While not as liquid as public REITs, private mortgage REITs offer more liquidity than direct real estate investments and enable investors to start with smaller amounts and add funds more flexibly
- Use of retirement funds: Some investors can use self-directed IRAs or 401(k)s to invest in private mortgage REITs, potentially growing their retirement savings
- Tax advantages: REITs are structured as something called pass-through entities, which can lead to potentially lower overall tax liability for investors—but be sure to consult with your tax advisor about your situation
- Diversification: Private mortgage REITs allow investors to diversify their portfolios and gain access to the real estate market without direct property ownership
- Low correlation to public markets: Private REITs typically have a lower correlation to stock market volatility, potentially offering more stability
- Professional management: Investors benefit from experienced management teams handling the complexities of mortgage investments
- Flexibility in investment strategies: Private REITs may have more flexibility to invest in non-traditional properties and capitalize on market inefficiencies
Mortgage REITs investments: The bottom line
Mortgage REITs can invest in various mortgage-related assets, including RMBS, CMBS, whole loans, and other real estate-related instruments.
For investors seeking exposure to the real estate financing market, understanding the intricacies of mREIT investments is vital for making informed decisions.
Reach out to Marquee Funding Group for investment opportunities
Investing in mREITs can be valuable to a diversified investment portfolio, providing both income and growth potential.
For more information on investing in private mortgage REITs, such as Marquee Funding Group’s Capital Fund 1—contact Marquee Funding Group.
Our experts can help you maximize the potential of your investment portfolio.