mREITs help provide essential liquidity for the real estate market. mREITs invest in residential and commercial mortgages, as well as residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS). mREITs typically focus on either the residential or commercial mortgage markets, although some invest in both RMBS and CMBS.
What are Mortgage REITs?
An individual may buy shares in a mREIT, which is listed on major stock exchanges, just like they do for any other public stock. Shares can also be purchased in a mutual fund or exchange-traded fund (ETF). Investors have historically found value in mREITs primarily because of their history of relatively high dividends.
mREITs play an important role in the economy by helping to facilitate the housing market by originating and purchasing mortgage-backed securities. In fact, mREITs help finance 2.8 million U.S. homes. On the commercial side, mREITs invest in commercial mortgages helping to finance the buying and selling of income-producing real estate.
mREITs provide a simple way to hold an equity investment in the mortgage market with the liquidity and transparency of publicly traded equities – advantages not available through direct investment in mortgage loans and mortgage-backed securities.
There are other mREITs whose shares are registered with the SEC but are not listed on any stock exchange. These public non-listed REITs (PNLRs) are typically sold to investors by a broker or financial advisor. Mortgage REITs also can be privately held.
How do you invest in mREITs?
mREITs hold mortgages and MBS on their balance sheets, and fund these investments with equity and debt capital. Their general objective is to earn a profit from their net interest margin, or the spread between interest income on their mortgage assets and their funding costs. mREITs rely on a variety of funding sources, including common and preferred equity, repurchase agreements, structured financing, convertible and long-term debt and other credit facilities. mREITs raise both debt and equity in the public capital markets.
mREITs typically use less borrowing and more equity capital to finance their acquisitions of mortgages and MBS than do other large mortgage investors.
What are the Benefits to Homeowners, Businesses and Financial Markets?
mREITs provide funding for mortgage credit for both homeowners and businesses. By using private capital to buy residential mortgages and mortgage-backed securities (RMBS), mREITs help provide liquidity and credit to home mortgage markets. Their financing activities have helped provide mortgage loans for 1.8 million homebuyers. Likewise, mREIT purchases of commercial mortgages and commercial mortgage-backed securities (CMBS) provide another source of mortgage credit for business investments in commercial real estate.
What are the Risks of mREIT Investing and how can you Manage Risk?
Most mREITs are registered with the SEC and are required to publish regular financial statements for review and monitoring by investors and analysts. The business risks that mREITs face are similar to those of other financial firms. mREITs have considerable experience managing many types of risk:Interest Rate Risk. Managing the effects of changes in short- and long-term interest rates is an essential element of mREITs’ business operations. Changes in interest rates can affect the net interest margin, which is mREITs’ fundamental source of earnings, but also may affect the value of their mortgage assets, which affects corporate net worth.
mREITs typically manage and mitigate risk associated with their short-term borrowings through conventional, widely-used hedging strategies, including interest rate swaps, swaptions, interest rate collars, caps or floors and other financial futures contracts. mREITs also manage risk in other ways, such as adjusting the average maturities on their assets as well as their borrowings and selling assets during periods of interest rate volatility to raise cash or reduce borrowings.
Credit Risk. The bulk of mortgage securities purchased by residential mREITs are agency securities backed by the federal government, which present limited credit risk. Commercial mREITs may be exposed to credit risk through their private-label RMBS and CMBS. The degree of credit risk for a particular security depends on the credit performance of the underlying loans, the structure of the security (that is, which classes of security are paid first, and which are paid later), and by the degree of over-collateralization (in which the face amount of the mortgage loans held as collateral exceeds the face amount of the RMBS or CMBS issued).
Prepayment. Changes in interest rates or borrower home sales affect the probability that some borrowers will refinance or repay their mortgages. When such a refinancing or repayment occurs, the investor holding the mortgage or MBS must reinvest the proceeds into the prevailing interest rate environment, which may be lower or higher. mREITs seek to hedge prepayment risk using similar tools and techniques as those they use to hedge against interest rate risks.
Rollover. mREIT assets are mainly longer-term MBS and mortgages, while their liabilities may include a significant amount of short-term debt, especially among residential mREITs. This term mismatch requires that they roll over their short-term debt before the maturity of their assets. Their ability to do so depends on the liquidity and smooth functioning of the short-term debt markets, including the repo market. The repo market is extremely liquid, with an estimated $2 trillion in outstandings and several hundred billion dollars in daily trading volume. Banks and dealers also use the repo market as an important source of market liquidity. In the financing markets, the liquidity of the agency MBS and TBA (To Be Announced) markets is comparable to the market for Treasuries. Commercial mREITs tend to match the duration of their assets and liabilities and face little rollover risk.