I’ve touted real estate investment trusts (REITs) quite a bit lately, and for good reason.
It’s my firm belief that every income portfolio needs to allot some space for these assets, especially in a low-yield environment. Going by the S&P 500’s roughly 1.6% yield, I’d say that’s the case right now.
Think of any type of property, and there’s a REIT for it. I just recommended one dedicated to document storage, for crying out loud.
You can even go beyond physical property and invest in the paper that owns the property through mortgage REITs.
Find out more about mortgage REITs, including why now is the perfect time to buy them, in this week’s Investing With Charles. Click below to watch it now, or keep scrolling for some of the highlights.
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The Difference Between Equity REITs and Mortgage REITs
REITs are great. It’s a great legal structure because REITs do not pay any federal income tax so long as they distribute 90% of their profits in the form of dividends. When you’re not paying federal income tax, that creates more money that you can then distribute as dividends.
When you talk about REITs, you’re normally talking about what’s called an equity REIT, which owns real property: hotels, apartments, office buildings and cell towers, to name just a few examples. Somebody is collecting rent on a tangible piece of property and then recycling that rent into a dividend.
There’s another corner of the market that’s different: mortgage REITs. These do not own real property. Instead, they own mortgages and mortgage-related investments, like mortgage-backed securities (MBS). They get the same tax benefits as an equity REIT.
Mortgage REITS: It’s All About Timing
Mortgage REITs are fun at the right time.
What these guys do is buy up a pool of mortgage-related assets and lever it up. Why do they lever up? Because you see, mortgage rates are near historic lows today. You don’t really want to invest just in mortgages. It’s not going to pay enough. But, if you can lever that up, if you can borrow cheaply and leverage 10-to-1 or 5-to-1, things can get a lot more interesting.
And that’s what mortgage REITs do. They borrow very cheap, short-term interest rates, and then they recycle that into buying mortgages and mortgage-related securities. The result is, you get some of the highest yields in the market almost all the time. Right now, you see mortgage REITs yielding between 7% and 10%.
There’s a time you want to invest in mortgage REITs, and there is a time you don’t. Right now, the yield curve is really steep. Short-term rates are near zero, and longer-term rates are more definitively positive. There is a very clear distinction between the two.
That’s nirvana for mortgage REITs. They’re able to borrow at effectively zero, and then recycle that into something yielding substantially more than zero. That’s a license to mint money.
The Worst Time to Buy
Now, there are times when you don’t want to own mortgage REITs. When the yield curve is flatter or inverted, it creates a nightmare scenario.
You also want to avoid this asset class when the Federal Reserve is aggressively trying to fight inflation. They’re jacking interest rates up. When they do that, the whole model becomes unprofitable.
At that point, mortgage REITS tend to be leveraged. They hedge with derivatives and other investment vehicles, but at the end of the day, the model just isn’t as good. It’s not as profitable in that environment.
How Mortgage Rates Are Doing Now
The Fed has made noise about raising rates, but they’re not going to do it tomorrow. Whenever it starts, if it’s next week or three years from now, it’s going to start slowly and build. So, we have a window of time in which to operate.
So, that’s the dynamics of mortgage REITs. That’s why they’re interesting. And this is a really nice sweet spot for them.
If you’d like to hear the rest of my conversation with Matt, click here. We talk about the Fed’s plan to taper off its bond-buying efforts and what that means for interest rates and mortgage REITs.
You can also read about a mortgage REIT I recommended in Money & Markets recently here.
Where to Find Us
Coming up this week, Matt will have more on The Bull & The Bear podcast, so stay tuned.
Don’t forget to check out our Ask Adam Anything video series, where chief investment strategist Adam O’Dell answers your questions.
You can also catch Matt every week on his Marijuana Market Update. If you are into cannabis investing, you don’t want to miss Matt’s weekly insights.
Remember, you can email my team and me at firstname.lastname@example.org — or leave a comment on YouTube. We love to hear from you! We may even feature your question or comment in a future edition of Investing With Charles.
To safe profits,
Co-Editor, Green Zone Fortunes
Charles Sizemore is the co-editor of Green Zone Fortunes and specializes in income and retirement topics. He is also a frequent guest on CNBC, Bloomberg and Fox Business.