Mortgage REITs (mREITS) purchase or originate mortgages and mortgage-backed securities (MBS) and earn income from the interest on these investments to fund income-producing real estate.
Are mortgage REITs a good investment?
When the spread between short-term and long-term interest rates (where they borrow) is substantial, mREITs can produce a significant net interest margin (where they lend). Unfortunately, the spread rarely remains broad for long, which makes mREITs extremely volatile. Because of this risk, mREITs aren’t always the best choice for income-seekers, as their high yields fluctuate drastically. A few fascinating mREITs, on the other hand, are worth investigating since their differentiated business strategies help buffer them from the sector’s overall volatility.
What are the risks of mortgage REITs?
Individual company strategies differ, but the riskiest aspect of investing in mortgage REITs is usually interest rates.
These businesses borrow money at cheaper short-term rates in order to purchase mortgages with periods of 15 or 30 years. If short-term interest rates stay the same or fall, this strategy works. However, if short-term borrowing rates rise, mortgage REIT profit margins could quickly collapse.
What is the difference between equity REITs and mortgage REITs?
Equity REITs own and run properties, and their primary source of revenue is rental income. Mortgage REITs make investments in mortgages, mortgage-backed securities, and similar assets, and earn money through interest payments.
Why REITs are a bad idea?
Because no investment is flawless, you should be aware of the possible negatives of REITs before incorporating them into your portfolio.
- Dividend taxation: REITs pay out higher-than-average dividends and aren’t subject to corporate taxation. The disadvantage is that REIT payouts don’t always qualify as “qualified dividends,” which are taxed at a lower rate than ordinary income.
- Interest rate sensitivity: Because rising interest rates are detrimental for REIT stock values, REITs can be extremely sensitive to interest rate movements. When the rates on risk-free investments like Treasury securities rise, the returns on other income-based investments rise as well. The yield on the 10-year Treasury is an excellent REIT indication.
- Real estate investment trusts (REITs) can help diversify your portfolio, but most REITs aren’t highly diversified. They tend to concentrate on a single property type, each with its own set of dangers. Hotel REITs, for example, are extremely vulnerable to economic downturns and other factors. If you decide to invest in REITs, it’s a good idea to pick a few with varying degrees of economic sensitivity.
- Fees and markups: While REITs provide liquidity, trading in and out of them comes at a significant price. The majority of a REIT’s fees are paid up front. They can account for 20% to 30% of the REIT’s total worth. This consumes a significant portion of your prospective profit.
How often do REITs fail?
Historically, buying REITs following a market crisis has always been a smart move, and we have little doubt that this time will be no different. REITs, on the other hand, aren’t “ideal investments.” In truth, there are numerous ways for a REIT investor to lose money. Over the last 20 years, REITs have returned 15% a year, according to NAREIT.
How do mortgage REITs pay high dividends?
Residential mortgage loans or pools of mortgage loans generated by qualifying financial institutions are purchased by these organizations. To be purchased, the mortgages must meet particular lending standards and other factors.
These mortgages are packaged by Fannie Mae, Freddie Mac, and Ginnie Mae into agency mortgage-backed securities, or MBS. Because the principal and interest paid by homeowners are passed on to the holders of mortgage-backed securities, these bonds are referred to as “pass-through securities.” The payment of the principal and interest on the mortgages that make up the agency mortgage-backed securities is guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae.
According to sifma, there were $8.1 trillion in outstanding US agency mortgage-backed securities as of September 30, 2020.
Fannie Mae, Freddie Mac, and Ginnie Mae all issue interest-bearing bonds known as agency securities in addition to mortgage-backed securities. The proceeds from these bonds are used to fund the agencies’ operations as well as to purchase mortgages that are later included in mortgage-backed securities.
Investors presume the US government will guarantee the performance of these bonds if Fannie Mae, Freddie Mac, or Ginnie Mae run into financial difficulties, therefore these three agencies can issue debt at extremely low yields. During the Great Financial Crisis of 2008 and 2009, this assumption proved right, as the US government did indeed offer financial support to these organizations, preventing their bonds from defaulting.
Non-Agency Mortgage-backed Securities
Non-agency mortgage-backed securities are also packaged by private issuers from pools of mortgages. To protect holders from defaults on the underlying mortgages, non-agency mortgage-backed securities may include insurance or other credit enhancements.
According to sifma, there were $1.3 trillion in non-agency mortgage-backed securities outstanding as of September 30, 2020.
How are mortgage REITs taxed?
Dividend payments are assigned to ordinary income, capital gains, and return of capital for tax reasons for REITs, each of which may be taxed at a different rate. Early in the year, all public firms, including REITs, must furnish shareholders with information indicating how the prior year’s dividends should be allocated for tax purposes. The Industry Data section contains a historical record of the allocation of REIT distributions between regular income, return of capital, and capital gains.
The majority of REIT dividends are taxed as ordinary income up to a maximum rate of 37% (returning to 39.6% in 2026), plus a 3.8 percent surtax on investment income. Through December 31, 2025, taxpayers can deduct 20% of their combined qualifying business income, which includes Qualified REIT Dividends. When the 20% deduction is taken into account, the highest effective tax rate on Qualified REIT Dividends is normally 29.6%.
REIT dividends, on the other hand, will be taxed at a lower rate in the following situations:
- When a REIT makes a capital gains distribution (tax rate of up to 20% plus a 3.8 percent surtax) or a return of capital dividend (tax rate of up to 20% plus a 3.8 percent surtax);
- When a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from
- When allowed, a REIT pays corporation taxes and keeps the profits (20 percent maximum tax rate, plus the 3.8 percent surtax).
Furthermore, the maximum capital gains rate of 20% (plus the 3.8 percent surtax) applies to the sale of REIT stock in general.
The withholding tax rate on REIT ordinary dividends paid to non-US investors is depicted in this graph.
How do REITs finance themselves?
REITs, like any other business, require capital. An IPO (initial public offering) is how a publicly traded REIT (real estate investment trust) accomplishes this. This is similar to selling any other stock to the general public, who are investing in the company’s income-producing real estate. People who purchase initial public offerings (IPOs) are investing in real estate that is managed similarly to a stock portfolio. These outside cash sources allow the REIT to acquire, develop, and manage real estate in order to generate profits. REITs generate income, and shareholders must get 90 percent of that taxable income on a regular basis. REITs create money by renting, leasing, or selling the assets they purchase. The shareholders elect a board of directors, which is in charge of selecting investments and recruiting a team to oversee them on a daily basis.
FFO stands for funds from operations, which is how most REIT earnings are calculated. FFO is defined by the National Association of Real Estate Investment Trusts (NAREIT) as the net income from rent and/or sales of properties after deducting administrative and financing costs. The NAREIT’s net income computations follow GAAP (generally recognized accounting rules). The issue is that depreciation of assets is presumed to be a predictable given in GAAP calculations, which skews the true measure of a REIT’s revenue in a negative direction because real estate, which is what REITs deal in, retains or even improves in value over time. As a result, depreciation is not included in FFO’s net income.
Do REITs take on debt?
Traditionally, these sources have been secured debt or mortgages, as well as public stock offers. Since 1993, equity REITs have increasingly relied on unsecured loans to meet their capital needs, rather than secured debt or stock.
Do REITs pay dividends?
A REIT is a security that invests directly in real estate and/or mortgages, comparable to a mutual fund. Mortgage REITs engage in portfolios of mortgages or mortgage-backed securities, whereas equity REITs invest mostly in commercial assets such as shopping malls, hotel hotels, and office buildings (MBSs). A hybrid REIT is a fund that invests in both. REIT shares are easy to buy and sell because they are traded on the open market.
All REITs have one thing in common: they pay dividends made up of rental income and capital gains. REITs must pay out at least 90% of their net earnings as dividends to shareholders in order to qualify as securities. REITs are given special tax treatment as a result of this; unlike a traditional business, they do not pay corporate taxes on the earnings they distribute. Regardless of whether the share price rises or falls, REITs must maintain a 90 percent payment.
How much debt should a REIT have?
as an illustration ” I don’t have Duke’s phone number on my screen right now, but email me privately while we’re not live, and we’ll talk about Duke.” In terms of REIT debt versus cash, there are a few factors to keep in mind. For one, REITs often operate with more debt than other businesses, and they do it in a healthy fashion. Consider this: when you buy a house, you typically have 80 percent of the house in debt and just 20 percent in equity. While this isn’t exactly the same, a REIT functioning in a 50 percent equity, 50 percent debt capitalization is completely fair. Debt to EBITDA is a key measure for me. That one appeals to me; I prefer it to be under the age of six. In terms of cash, most REITs don’t keep a lot of cash on hand in regular times. REITs have taken down their credit lines to ensure they have adequate liquidity to go through whatever lies ahead, as you can see on one today. REITs don’t usually hold a lot of cash in normal times. It’s not a good business model to keep a lot more cash than you need, especially when almost all REITs, with the exception of the malls that recently went bankrupt, are quite cash flow positive in normal circumstances. As a result, they don’t need to store much cash in the bank.
