Do mortgage REITs give a debt investor real lending exposure, or is that a category confusion?

Question

For an investor whose interest is lending rather than owning, REITs come up as a way to get exposure to real estate credit without originating anything. The standard definition says a REIT owns or finances income-producing real estate, and the financing half is where the question usually gets stuck. Broadly there are equity REITs that own buildings and mortgage REITs that hold loans, and the return numbers most people quote, the 9 percent, the 4 to 6 percent yields, come from the equity side. Are mortgage REITs a different animal entirely or a variant of the same thing? And for someone who wants exposure to the lending side of real estate, is a mortgage REIT the closest thing available on a public exchange, or is there something more direct that tends to get overlooked?

Rena Guide · Accepted Answer

Mortgage REITs are a genuinely different business from equity REITs, and the numbers you've seen almost certainly describe the equity side. The FTSE NAREIT All Equity REIT index, where that roughly 9 percent long-run annualized figure and the 4 to 6 percent yield range come from, holds equity REITs. Mortgage REITs sit in separate indexes.

An equity REIT owns buildings and collects rent. Its risks are occupancy, rent growth, supply and management quality. A mortgage REIT holds mortgages or mortgage-backed securities and earns the spread between what it pays to borrow and what its loans pay. Its risks are the shape of the yield curve, prepayment speeds, and credit quality on the underlying loans. Mortgage REITs also tend to carry considerably more borrowing relative to equity, which is why their dividend yields often look higher and why their share prices can move violently when rates shift. High yield there reflects a leveraged spread business rather than rent from buildings.

So yes, a mortgage REIT is the most accessible public route to real estate credit exposure, and it's a distinct set of risks from the ones the equity REIT valuation-convergence discussion is about. That discussion, depressed valuations against both broader equities and private real estate, tightening new supply granting pricing power, is an equity REIT argument. It doesn't transfer.

One thing to check before you buy either: mortgage REIT distributions have their own tax character, and REIT distributions generally are largely nonqualified rather than qualified. A tax professional can tell you how that lands in your particular accounts.

diane_kowalski · Answer

The leverage point is the one I'd sit with. I looked at a couple of mortgage REITs while researching income options and the debt-to-equity ratios were nothing like what the apartment REITs were running. Book value per share moved around a lot too. It didn't feel like the boring holding I was after, so I stopped there.

Do mortgage REITs give a debt investor real lending exposure, or is that a category confusion?

2 replies