More than 65% of Americans currently own real estate, according to Census Bureau data. While a good portion probably live in the homes that they own, there are many homeowners who instead purchase property for investment purposes. Investing in real estate isn’t for everyone, though, as there are many aspects of owning a real estate investment that don’t appeal to all investors (such as dealing with tenants or hiring a property manager). If you’re not interested in buying a property outright but would still like to add real estate investments to your portfolio, there is another option to consider: the mortgage REIT.
There are a myriad of ways to invest in real estate, and a financial advisor can provide valuable guidance as to which ways fit your goals, timeline and risk profile.
What Is a REIT?
A standard REIT, or real estate investment trust, is a company that invests in real property. This might mean financing the construction of a new apartment complex, funding a medical facility or even building cell towers. In some cases, a REIT will own and operate the property, as well. But whatever the case, these kinds of securities are equity investments.
REITs allow investors of all levels to invest in real estate, by buying into asset portfolios. The REIT will use that money to fund certain real estate projects; when those projects generate income — through the sale of units or perhaps the leasing of office spaces — the investors will receive a share of those earnings in the form of dividends.
Adding REITs to your portfolio can be an excellent way to diversify the equity component of your investments as well as create passive cash flow. While no investment is ever guaranteed, REITs traditionally deliver strong returns.
How a Mortgage REIT Works
Mortgage REITs, also referred to as mREITs, work a bit differently. These are not equity investments; they are essentially a lender. They play an integral role in providing liquidity to the real estate market, helping to fund businesses and homeowners alike. With an mREIT, the investment lies within the property’s mortgage itself. An mREIT will invest in mortgages and mortgage-backed securities (MBS), for either commercial or residential property. Mortgage REITs will either originate mortgages or purchase those mortgage-backed securities down the line.
Thanks to mREITS, homeowners and developers alike can access mortgage funding for their personal property and commercial projects, while investors are able to invest in those mortgages and earn a return.
Investors are able to invest in mREITs as they would a mutual fund, exchange-traded fund(ETF) or publicly traded stock. The goal of mREITs is to earn a profit between their mortgage funding costs and the interest charges on those assets. After purchasing shares of a mortgage REIT, investors will benefit from the net profit margin that the mREIT recognizes. In most cases, investors will receive regular dividend payouts from their mREIT investments.
Benefits of Mortgage REITs
Not sure if mREITs are right for you? There are a few key benefits to keep in mind.
If you’re looking for a strong real estate investment – but don’t necessarily want to purchase (and manage) physical property – mortgage REITs can be the answer. These investments allow you to fund and benefit from real estate projects, without the hassle and headache of day-to-day management. You don’t have to worry about building delays, vacancies or water heater issues with tenants. You simply invest in shares of the mortgage REIT of your choice.
Per the IRS, at least, 90% of an mREIT’s taxable income must be paid out to shareholders. Because of this, the funds are generally well-managed and investors can typically expect strong dividends on a regular basis. In other words, mREITs can be a good source of passive income.
Mortgage REITs play a very important role in providing liquidity for mortgage-based ventures, whether funding personal or commercial projects. Investing in mREITs allows investors to help support the mortgage industry and keep it on stable ground. This is a self-perpetuating cycle: investors continue to benefit from a strong mortgage industry, which their investment helps to maintain.
Risks of Mortgage REITs
As with all investments, mREITs are not without risk. Some of these could impact the recognized returns on your investment, so it’s important to consider each one.
Contracts Ending Early
A mortgage lender’s profit comes primarily from the interest earned over the repayment term of the loan. If a borrower ends that repayment term early — either by paying off the loan ahead of schedule or refinancing for a lower rate with another lender — it will impact the total profit. Depending on which mortgage loans your mREIT invests in, contracts that are ended early can unexpectedly affect your returns.
Since interest and interest rates are integral to a mortgage REIT’s success, fluctuating interest rates play a direct role. If market interest rates drop, for instance, new originations and purchased mortgages will have a lower profit margin than those issued at a higher interest rate. Additionally, once mortgage rates drop, mortgage borrowers tend to refinance their loans to take advantage of lower rates. This could result in reduced profit on some loans and the loss of other loans altogether.
Mortgage REITs hinge on the contracted repayment of a mortgage loan. If the borrower defaults, however, the lender (in this case, your mREIT) could be seriously affected. The risks involved with loan default are greater when investing in mortgages that aren’t backed by a government agency, such as Freddie Mac or Fannie Mae.
The Bottom Line
Mortgage REITs offer a simple, straightforward way to invest in real estate property. Investors can reap the benefits of mortgage returns without shouldering the hassle of property management, often with steady and robust dividend returns. But they are not without risks. It’s important to note both the benefits and downsides to this real estate investment option, before adding mortgage REITs to your portfolio.
Tips on Investing
- There are myriad ways to invest in real estate. Understanding all our options can be a challenge. That’s why working with a financial advisor makes a great deal of sense. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s matching tool can connect you with several in your area, in just minutes. If you’re ready, get started now.
- Want to take a look at what your portfolio will look like in a decade? SmartAsset’s investment calculator can help you do just that. Enter how much you have invested, how much you’re contributing and what rate of return you expect. We’ll then show you your investment growth five, 10 or even 30 years into the future.
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