Real estate investment trusts, or REITs, made the news recently when the first one in India came out with an IPO. REITs are like mutual funds for real estate, and enable investors to make investments in the sector, without having to put in large sums. This, along with fact that they are listed on stock exchanges and hence liquid, make REITs an attractive proposition. There are many types of REITs, including equity REITS which are the most common, and mortgage REITs, a.k.a. mREITs.
So what are mortgage REITs? These are REITs that loan money for mortgages to property owners or developers, or purchase mortgages. In other words, these are like debt funds that invest in real estate debt. They generate revenue through the interest rates they earn from this debt and distribute it to investors in the form of dividends.
There are no mortgage REITs in India at present, but they could make an entry here in the next few years. It’s an investment opportunity, so you should be able to find the best mortgage REITs in order to profit from them.
Features of mortage REITs
• Interest rate risk: Timing is essential while investing in mREITS. There is a direct correlation between mortgage REITs and interest rates. If interest rates are rising, mREITs facing increasing cost of debt, and this will affect returns to investors. Mortage REITs and rising interest rates do not go well together. The top mortgage REITs, however, can make profits even when interest rates are rising. For example, higher interest rates are generally an indication of economic growth and increased demand, and this could increase demand for office and residential properties. This could mean more opportunities for a savvy mREIT management
• Credit risk: Another feature of mortgage REITS is credit risk. In an economic downturn, property demand could fall, leading to losses for real estate companies and thus defaults.
• Excessive borrowing: Mortgage real estate investment trusts use high leverage, that is, borrowing to fund operations. So they can be hit particularly hard during times of interest rate volatility.
• Diversification avenue: As we have seen, mortgage REITs can be a high-return, high-risk business. But if you want to diversify your portfolio, and want some exposure to real estate without spending a lot on acquiring property, mREITs could be the way to go. This is a good diversification option because returns from mREITs don’t have much of a correlation with asset classes like equity. That is, when returns from equity are low, those from mREITs could be high and so on.
• Types of mREITs: Even within the mREITs category, there are different types. Some mREITs, for example, invest only in home mortgages, while others go for the commercial sector. In the US, risks from home mortgages are lower since they are insured against default by organisations like Federal National Mortgage Association, commonly known as Fannie Mae.
Investing in mREITs is not without risk, but the dividends from the best mortgage REITs could be handsome too. But you must go into it with your eyes wide open, considering factors like interest rates, economic growth and the state of the real estate industry.