investing

3 Great Picks to Earn 8% - 11% From Mortgage REITs

The main hazard to these high-yielding investments is a gap between short- and long-term rates.

Interest rates average about 4.1% for a 30-year home loan. But mortgage REITs, which invest primarily in pools of residential mortgages, have found ways to yield much more. The firms use some of their own cash to buy mortgage-backed securities. They also load up on short-term debt to buy assets, and many boost their payouts with other types of real estate loans or direct lending to property owners.

All this may sound like a house of cards. But the business does feature an important safeguard: Most big mortgage REITs stick mainly with securities issued by government-sponsored firms, such as Fannie Mae. That effectively eliminates credit risk.

Risks to your money. The main threat to mortgage REITs is if short-term rates rise without a corresponding bump in long-term rates, squeezing their income (and dividends). The gap between short-term and long-term rates has narrowed recently. The Fed has raised short-term rates twice, while long-term rates, which are set in the bond market, have eased. Yet mortgage REITs have held steady—returning an average of 10.8% in the first quarter of 2017—partly because the firms have maintained their payouts. Jeffrey Gundlach, CEO of DoubleLine Capital Management, sees a tougher rate climate for mortgage REITs this year. But he advises holding the stocks. “Investors should not expect price gains, but the dividends alone should lead to decent returns this year,” he says.

How to invest. Annaly Capital Management (NLY, $11, 11.0%), the largest mortgage REIT, with $87.9 billion in assets, invests primarily in government-backed mortgage securities. Income from those investments could dwindle if the gap between short- and long-term rates shrinks. But Annaly has been expanding into adjustable-rate mortgages, which would do better than fixed-rate loans if rates were to rise. It has also been adding commercial real estate loans and other types of loans to its portfolio, investments that may help Annaly maintain its payouts.

Blackstone Mortgage Trust (BXMT, $31, 8.0%) isn’t a traditional mortgage REIT. Affiliated with Blackstone Group, a large commercial property owner, the firm makes loans to developers and real estate owners in North America and Europe. Nearly 90% of its portfolio consists of floating-rate loans that will yield more as short-term rates climb. Furthermore, Blackstone’s portfolio of loans is expanding, and the firm possesses plenty of financial firepower to buy more assets and hike its dividends, says Credit Suisse, which rates the stock “outperform.”

The best bet for fund investors is iShares Mortgage Real Estate Capped ETF (REM, $45, 9.5%), which recently owned 34 stocks, with a tilt toward the biggest firms. The fund holds some cash and shares of other real estate firms that don’t pay as much as those that primarily invest in mortgages. The ETF, which charges 0.48% annually in fees, returned 9.0% annualized over the past five years.

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