Most REITs invest in office buildings, shopping malls and other kinds of commercial properties. However, a relatively small but extremely high-yielding segment of the REIT world specializes in lending money to owners of property or buying mortgages or mortgage-backed securities. Mortgage REITs typically borrow money at short-term interest rates and lend it at long-term rates.
What could go wrong: The big risk, as with any kind of income-oriented investment, is rising interest rates. Mortgage REITs accentuate the risk of rising rates because they use leverage—that is, borrowed money—to amplify their returns. If rates start to rise rapidly, or if there is even a hint that rates will rise, mortgage REITs can get slammed, as they did in the spring and summer of 2013, after the Fed suggested it might soon begin tapering its bond-buying program (which has since ended).
How to play them: Look for REITs that either lend at variable interest rates or are good at hedging their interest-rate risk. Tim Plaehn, analyst for income investing at Investors Alley, a research service, likes Blackstone Mortgage Trust (BXMT, $28, 7.3%) and Starwood Property Trust (STWD, $24, 7.9%), both of which make commercial loans at variable interest rates. Among mortgage REITs that are hedging against the threat of rising rates, analyst Merrill Ross, of Wunderlich Securities, favors American Capital Agency Corp. (AGNC, $21, 12.4%) and AG Mortgage Investment Trust (MITT, $19, 12.7%). Ross thinks that their share prices could climb once investors realize that worries about rising interest rates are overblown. Or take the worries out of picking individual mortgage REITs by investing in one of the two ETFs that buy a diversified package of them. Market Vectors Mortgage REIT Income ETF (MORT, 10.5%) gets a slight edge over iShares Mortgage Real Estate Capped (REM, 10.1%) because of its slightly higher yield and slightly lower expenses.
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