In Search of Yield:  Mortgage REITs

October, 2012

For the last 30 years, fixed income investors have enjoyed a bull market.  Interest rates were at all time highs in 1981, and investors could buy very high quality 10 year bonds that paid 15%+ annual interest rates while experiencing relatively low inflation.  Investors could realize a real (net of inflation) return of about 11% while incurring very little risk.

Today is a very different story.  The safest 10 year bonds yield 1.5-2.0%, while inflation is running at about 2.2%, so the real return is negative.  Yield starved investors and investment managers have scoured the economic landscape for suitable replacements.  Over the past several years, money has flowed into high yield (“junk”) bonds, longer maturity bonds, mortgage backed bonds, emerging market government bonds, and dividend paying stocks (like electric utilities and telephone companies).  In the end, investors have been forced to accept significantly more risk to generate a yield that outpaces inflation.  One lesser known type of investment that has generated big dividend yields over the past several years has been mortgage REITs.  In fact, certain mortgage REITs currently have a dividend yield of 11-14%.  Of course, past performance cannot guarantee future results.

This paper discusses what REITs are and then defines Mortgage REITs.  It describes the risks associated with the three major classes of mortgage REITs, the investing criteria we use when we look at mortgage REITs, and the risks associated with these companies.  Finally, it concludes with some of the questions a prospective investor should ask when evaluating individual mortgage REIT companies. 

With annual dividend yields of 11-14%, mortgage REITs can be incredibly alluring to investors.  Caution is recommended when considering this kind of investment, and exposure should be limited in portfolios in which it is suitable.  It is very important to understand the details of any mortgage REIT before investing.

This information is provided for informational purposes only.  The information contained herein is from sources believed to be reliable, but its accuracy or completeness is not guaranteed.  This information should not be construed as an offer to sell or a solicitation of an offer to buy any security by PlanStrong Investment Management.  Any opinions expressed herein are subject to change without notice.  Past performance is not a guarantee of future returns.

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