Mortgage REITs in the Spotlight
This month, an income-generating asset class has gained attention, particularly for investors willing to accept some risk for attractive dividend returns. Mortgage real estate investment trusts (REITs) specialize in holding mortgages and mortgage-backed securities, providing loans to developers and other entities for various real estate projects, as well as investing in mortgage loans.
Understanding Mortgage REITs
Unlike equity REITs, which buy properties and earn rent from tenants, mortgage REITs operate differently. Earlier this month, renowned investor Bill Gross mentioned mortgage REITs on social media platform X, highlighting his investment in AGNC, which boasts a yield of 13%. He pointed out that while mortgage REITs could perform well at a yield of 4.25%, it seems unlikely yields will decrease without visible progress in inflation.
Earning Potential vs. Risk
Currently, AGNC Investment is promoting a notable dividend yield of 14%, with the stock appreciating about 12% this year, an appealing prospect during a time when the S&P 500 has fallen over 3%. However, financial experts caution investors against hastily entering this market solely for potential high returns. “You must comprehend what you’re investing in,” advised Philip Blancato, chief market strategist at Osaic. “There are scenarios where you can get whipsawed in these things.”
Risk Profile of Mortgage REITs
Mortgage REITs possess a distinct risk profile compared to their equity counterparts. They often operate with substantial leverage, utilizing significant debt to acquire mortgages. While this can enhance returns, it also increases their risk levels, as noted by Matthew Malone, head of investment management at Opto Investments. Mortgage REITs can be leveraged five to seven times, meaning they could have five parts debt to one part equity.
Interest Rate and Credit Risks
Interest rate risk, known as duration, adds another layer of risk for mortgage REITs. Longer-term mortgages may yield higher returns but are also sensitive to interest rate changes. Additionally, the choice between high-quality agency mortgages and riskier options with higher default probabilities further complicates their risk profile. Rising interest rates can jeopardize mortgage REITs, leading to potential profit losses if they make poor timing decisions in their interest rate strategies.
Current Market Conditions
Right now, the 10-year Treasury yield sits around 4.2%, down from 4.8% at the beginning of the year, presenting a favorable environment for mortgage REITs. Among those performing well in 2025 are Annaly Capital Management, which is up nearly 19% with a 13% dividend yield, and Dynex Capital, up 11% with a 14.5% yield. Investors should also consider that companies like Annaly and AGNC may trade at premiums to their net asset values, impacting potential investments.
Investor Considerations
While mortgage REITs can be risky for individual investors, institutional investors often use them as a diversification tool alongside other income-generating assets. It’s crucial for investors to understand the underlying portfolio of a mortgage REIT, focusing on quality credit, shorter durations, and sustainable yields. “Ensure they own Treasuries, seek relatively short duration, and don’t chase the highest yield,” Blancato advised. “These REITs should not constitute a large part of any portfolio due to their risk characteristics. They can enhance your portfolio, but they shouldn’t be the foundation.”
