Mortgage REITs show strong yields, but caution necessary

Mortgage real estate investment trusts (REITs) are currently performing well despite a challenging market. These investments can be appealing to those who accept higher risks for substantial dividend yields. Unlike equity REITs, which buy properties and collect rent, mortgage REITs invest in mortgages and mortgage-backed securities. Bill Gross, a prominent investor, recently highlighted mortgage REITs, mentioning a particular REIT called AGNC, which boasts a 14% dividend yield. In contrast, the S&P 500 index is down over 3% this year. This performance has sparked interest among investors looking for better returns. However, experts advise caution before jumping into this market. Philip Blancato, chief market strategist at Osaic, emphasizes the importance of understanding the risks involved. Mortgage REITs often rely heavily on debt, which can amplify both returns and risks. They can be significantly levered, with ratios of five to seven parts debt for every one part equity. Changes in interest rates can also greatly affect their performance. Investors must consider the quality of the mortgages held by these REITs. While some focus on safer agency mortgages, others might pursue riskier options with the potential for higher yields. Rising interest rates can present challenges for mortgage REITs, and mistakes in this area can lead to severe financial losses, according to Blancato. Currently, the 10-year Treasury yield is around 4.2%, down from earlier highs. Some mortgage REITs, like Annaly Capital Management, are thriving, boasting significant stock gains and solid dividend yields. However, potential investors should be cautious about buying at high prices compared to the REITs' net asset values. While mortgage REITs may be too risky for individual investors, institutional investors often use them to diversify their portfolios. Those interested in this investment should carefully evaluate the quality of the underlying assets and avoid focusing solely on yield. Experts recommend that these REITs should only make up a small part of an investment portfolio, serving as a supplement rather than the foundation of a strategy.