Generally speaking, Wall Street investment firms are the most visible cheerleaders for the stock market. Wall Street analysts issue far more buy ratings on stocks than sell ratings for a variety of reasons. For example, the stock market has shown that it historically increases in value over time. Thus, a bullish call on individual equities would appear to give analysts a better chance of being correct over time.

Furthermore, Wall Street investment firms can offer financial products and services to the companies they cover. Offering up a negative rating on a company can burn bridges and cost investment firms future business.

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However, once in a blue moon Wall Street snubs its nose at a particular industry and turns bearish on it. As an example, oil and gas drillers, which in some cases have lost more than 90% of their value since 2016, are receiving little love on Wall Street. Then again, with large debt loads, global crude oversupply concerns, and plenty of competition in the onshore and offshore drilling space, there's a reasonable argument to be made for Wall Street's skepticism.

But there's another industry Wall Street hates that I believe is ripe to be bought: mortgage real estate investment trusts (REIT).

Wall Street is no fan of mortgage REITs

A mortgage REIT is a company that borrows money at a short-term lending rate, then aims to acquire assets, such as mortgage-backed securities (MBS), which have a considerably higher long-term yield. The difference between this long-term yield and what's owed via short-term borrowing represents the net interest margin. The wider this gap, the more profits that a mortgage REIT will earn. It's also common for mortgage REITs to lean on leverage to bolster their profitability.

Though the business model is pretty easy to understand, it's come under fire in recent years by Wall Street. You see, mortgage REITs are typically in their best shape when interest rates remain low and/or steady. An environment when lending rates are rising, or changing rapidly, doesn't give mortgage REITs an opportunity to adjust their holdings or leverage to maximize their profitability. As a result, net interest margins tend to be squeezed.

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Between December 2015 and December 2018, the Federal Reserve wound up increasing the federal funds rate by 25 basis points on nine separate occasions. Wall Street also anticipated this eventual lift from record-low lending rates well in advance of December 2015. As a result, margins have been squeezed on mortgage REITs for the better part of a half-decade, which has drawn negative reviews from Wall Street.

What's more, since REITs are required to pay out a high percentage of their earnings in the form of a dividend, lower net interest margins can also lead to dividend cuts. A big reason investors buy into mortgage REIT stocks is their high-yield dividend, so you can see the problem here. And yes, we have seen quarterly payouts decline for mortgage REITs in recent years, even though their aggregate yields remain very high.

Additionally, as with most REITs, one of the most common ways to raise capital in order to purchase new assets is to sell common stock. For instance, Annaly Capital Management (NLY -0.85%) offered 75 million shares to raise $731 million in gross proceed in January 2019. Offering stock, while effective at raising money for REITs, ultimately dilutes existing shareholders. 

It's for all these reasons that popular mortgage REITs like Annaly Capital Management and AGNC Investment Corp. (AGNC -0.64%) are currently trading above Wall Street's consensus price targets for these stocks.

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It's time to buy mortgage REITs

I'll be the first to admit that mortgage REITs didn't offer an attractive investment profile throughout much of the 2010s. Access to historically cheap capital made growth stocks far more attractive to investors, while the expectation of higher lending rates pinched margins for mortgage REITs. In fact, the very brief yield-curve inversion in late Aug. 2019 is about the worst-case scenario for an industry that counts on longer-term yields to handily outpace short-term yields.

However, mortgage REITs look to be a screaming buy right now for a number of reasons. Perhaps the biggest is that we're seeing the Federal Reserve hit the pause button on interest rates. The nation's central bank wants to assess how three 25-basis-point cuts to the federal funds rate, implemented in 2019, will affect the U.S. economy. Having the Fed walk on eggshells and announce their moves well in advance is an absolutely perfect scenario for Annaly and AGNC Investment to put their capital to work, as well as lever up, without any surprises. Remember, it's not just declining interest rates that's generally a positive for mortgage REITs. It's also about the interval and magnitude of the moves that the Fed undertakes.

Furthermore, history shows that yield-curve inversions are typically followed by an extended but steady widening of long- and short-term yields. Essentially, the worst is over, in terms of net interest margins being squeezed.

Another point to consider is that, while Wall Street and investors are concerned about a possible recession on the horizon, Annaly Capital Management and AGNC Investment are predominantly protected from this weakness due to their assets held. As "agency-only" mortgage REITs, they invest in MBSs that are protected by the federal government in the event of default. While this means the yields on these MBSs are considerably lower than non-agency mortgage assets, it also means that leverage can be used to pump up profits.

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At the end of 2019, AGNC's portfolio consisted of $105.5 billion in fixed-rate, agency-only securities, compared to only $1.6 billion in non-agency assets. The story is similar for Annaly, which ended September with $114.5 billion in agency-backed MBSs out of $116.1 billion in total securities held. 

There's also the ultra-high yields of mortgage REITs, which deliver more impressive total returns than you might realize. For instance, even though Annaly's share price declined 46% last decade, its total return, which includes dividends paid, was 81%. AGNC Investment was even more prolific, with a 33% share price decline, but a total return including dividends of 171%. If mortgage REITs can deliver these types of returns during a challenging time, imagine what'll happen when net interest margins widen, which is what I expect to happen over the next five to 10 years.

Annaly Capital Management and AGNC Investment aren't sexy by any means. But there's no reason to believe these ultra-high-yield stocks, and the mortgage REIT industry, in general, can't deliver for investors in the years to come.