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Mortgage REITs are a subcategory of the real estate investment trust (REIT) segment that focuses on real estate financing. The entities purchase or originate mortgages and mortgage-backed securities, earning interest income from their investments. Some mREITs also earn loan origination and servicing fees. These factors make mREITs similar to financial stocks.
Mortgage REITs make money differently than other real estate investments. They earn a profit on their net interest margin, which is the spread between the interest income generated by their mortgage assets and their funding costs. Mortgage REITs use various funding sources to originate and purchase mortgages and related securities. This can include common and preferred equity, repurchase agreements, structured financing, convertible and long-term debt, and credit facilities.
Mortgage REITs use those funding sources to acquire mortgage-related assets. Some mREITs will originate loans they hold on their balance sheet and sell them to other buyers, including government agencies, banks, or investors. In addition, mREITs purchase mortgages and mortgage-backed securities. They collect the fees and loan interest generated by mortgages, keeping what remains after paying funding and operating expenses.
Here's an example of how mREITs work. Let's say an mREIT raises $100 million of equity from investors to buy mortgages. It secures another $400 million in capital from other sources, at an average funding cost of 2%, allowing it to purchase $500 million of mortgage-backed securities.
If the loans had an average weighted yield of 3%, they would generate $15 million of interest income annually. Meanwhile, at a 2% cost of funding, it would have $8 million of annual funding costs, allowing the mREIT to generate $7 million of net interest margin each year.
IRS guidelines for mREITs require them to distribute 90% of net income to shareholders via dividend payments, which explains the high dividend yields for most mREITs.
Mortgage REITs are riskier than many other investments, including other REITs, because they face certain specific risks, including:
There are several dozen mREITs, and many have underperformed the S&P 500 in recent years due to fluctuating interest rates. However, a couple of mREITs stand out as strong candidates in this volatile sector and could be worth a look for patient investors who want high income streams.
Arbor Realty Trust is an mREIT that finances commercial real estate. It focuses on making loans backed by multifamily properties, single-family rentals, and land.
The real estate financing company has three business platforms:
Arbor's business model provides it with multiple income streams. The mREIT produces recurring long-dated cash flow from servicing fees, escrow revenue, and net interest income. It also generates one-time origination fees. This strategy gives it an advantage over mREITs solely focused on making money via the net interest margin.
Its diversified operating platform and multifamily focus have enabled it to generate fairly steady earnings in all market cycles. Arbor has delivered more than a decade of paying dividends at or above the previous quarter's level. That's notable since many mREITs have reduced their dividends in recent years because of the impact interest rates have had on their net interest margin.
Mortgage REITs can generate a significant net interest margin when there's a wide spread between short-term interest rates (where they borrow) and long-term interest rates (where they lend). Unfortunately, the spread doesn't usually stay wide for long, which is why mREITs tend to be very volatile.
Because of that risk, mREITs aren't always the best option for income-seeking investors since their high yields fluctuate wildly. However, a couple of interesting mREITs are worth considering, as their differentiated business models help insulate them from the sector's overall volatility.
Mortgage REITs, or mREITs, provide real estate financing by originating or purchasing mortgages or mortgage-backed securities. They are an essential part of the residential mortgage market, helping to finance about 1 million homes in the United States each year. They also support the commercial real estate sector by providing loans to develop, acquire, reposition, and own income-producing properties.
Here's a closer look at the overall mortgage REIT market and the sector's unique risks. Plus, we'll discuss a couple of interesting mREITs you might want to consider.
Here's a closer look at these two leading mortgage REITs.
AGNC Investment is an mREIT focused on investing in mortgage-backed securities protected against credit losses by government agencies like Fannie Mae, Freddie Mac, and Ginnie Mae. The REIT invests in mortgage-backed securities on a leveraged basis, primarily using repurchase agreements. It also uses a dynamic risk management strategy to protect the value of its portfolio from interest rate and other risks.
The REIT's strategy has enabled it to pay a stable monthly dividend for the last several years. That dividend stability has made it stand out in a sector where many of its rivals have reduced their dividend payments as interest rates rose.
| Name and ticker | Market cap | Dividend yield | Sector |
|---|---|---|---|
| Arbor Realty Trust (NYSE:ABR) | $2.3 billion | 12.35% | Financials |
| AGNC Investment Corp. (NASDAQ:AGNC) | $10.2 billion | 14.69% | Financials |
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