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What Is a Mortgage REIT (mREIT) – Definition, Risks & Suitability

Want to diversify your portfolio to include real estate, without the 3am phone calls from tenants asking you to change their light bulb? 

Anyone with a brokerage account can buy shares in real estate investment trusts, better known as REITs. These companies come in all shapes and sizes, with different strategies to invest in real estate. Included among them: REITs that own debts secured by real estate, rather than owning properties directly. 

They often pay huge dividend yields too. But like any investment, they come with risks to pair with those returns. 

What Is a Mortgage REIT (mREIT)?

The “m” stands for “mortgage,” as mREITs are a special group of REITs that base their real estate investments in the mortgage market. For the most part, this means that mREITs buy mortgage securities on the secondary mortgage market.

After a bank lends money to someone buying a house, the lender sells that mortgage to a residential mortgage buyer (such as an mREIT). Some mREITs only buy conventional mortgages backed by a quasi-governmental organization like Fannie Mae, Freddie Mac, or Ginnie Mae. Because they come with a guarantee from the federal government — and thus low risk of losses — these loans come with relatively low interest rates and profits.

Other mREITs, sometimes called nonagency mREITs, specialize in mortgages not guaranteed by the government. These include not just residential but commercial mortgages, and tend to pay higher dividends as the loans pay higher interest given the higher risk. You can buy shares in residential mortgage REITs, commercial mREITs, or mREITs that own both types of debt. 

How mREITs Work

Investors can buy shares in mREITs through a free brokerage account, like any other publicly traded stock. As a partial owner in the company, shareholders receive dividends from mREITs.

Usually high dividends, at that. By their very nature, loans generate their returns from interest income rather than by growing in value over time. And the SEC requires REITs to pay out at least 90% of their profits each year to shareholders in the form of dividends. That combination makes for high dividend yields. 

Since mortgage rates are tied to the government bond market, changes in interest rates affect mREITs as well. Because mREITs have to pay out nearly all their profits in dividends, they have to borrow money in order to buy more mortgage loans. Simply put, mREITs borrow money at short-term bond interest rates and lend it at rates near the higher long-term bond rates. 

Mortgage REIT profits are directly proportional to the gap (or “spread”) between short-term and long-term bond rates. The larger the gap between short-term and long-term bond rates, the more profitable the mREIT business becomes. 

Like other public companies, mREITs fluctuate in value throughout trading hours, based on what buyers are willing to pay for shares. When investors believe that an mREIT will become less profitable, the share price goes down. Since many investors look at mREITs as a source of passive income thanks to those high dividends, mREIT shares also depreciate if investors think that dividends will go down.

Pros & Cons of mREITS

Every investment comes with upsides and downsides. Make sure you understand both before investing in mREITs — or anything else, for that matter.

Pros of mREITs

Why should you consider investing in mREITs? In so many words, for their relatively high income potential, ease of access, and favorable tax treatment.

  • High Dividend Yields. Some investors prize passive income above everything else. In particular, retirees need passive income streams to live on, so they tend to look for high-yield investments.
  • Low Minimum Investment. You can invest in a REIT for the cost of a single share, sometimes as low as $5 or $10. Compare that to lending a homeowner their entire mortgage, or putting $40,000 down payment on an investment property. 
  • Diversification. These companies offer a simple way to add real estate to your investment portfolio. 
  • Liquidity. Unlike physical real estate — which costs thousands of dollars and often takes months to sell — you can buy and sell shares in REITs instantly. 
  • No Corporate Tax: As part of their regulation, REITs who pay out 90% of their profits back to shareholders don’t have to pay corporate taxes. That leaves more profit for shareholders, who avoid effectively paying taxes twice — once at the corporate level and again at the individual level. 

Cons of mREITs

Mortgage REITs come with plenty of disadvantages too: 

  • Correlation to Stock Markets. Because they trade on public stock exchanges, REITs tend to move in closer concert with stocks than the underlying investments merit. That can defeat the purpose of diversifying into real estate. 
  • Correlation to Interest Rates. As outlined above, mREITs are closely tied to mortgage interest rates and the Fed funds rate. When interest rates go up, it can wreak havoc on mREIT share prices and profits. That creates interest rate risk on top of the default risk on the underlying loans. 
  • Taxes on Dividends. Most investors choose mREITs for the dividends, but the IRS taxes dividend payments at your ordinary income tax rate. Compare that to growth stocks, which costs you the lower long-term capital gains tax rate on profits if you hold for at least a year. 
  • Limited Growth Potential. Since REITs have to hand nearly all their profits back to investors each year, it leaves them little money to reinvest and grow their portfolios. That limits the upside potential for share price growth. 

Should You Invest in mREITs?

Mortgage REITs can offer a strong source of passive income, and an alternative to higher-yield bonds. That makes them an attractive investment for retirees and older workers preparing to retire. 

But as an alternative to other real estate investments, I find that public REITs come up short. They often drop in value alongside stocks, which ruins their diversification value. I’ve also found better returns among other types of real estate investments, such as real estate crowdfunding, direct property investing, and real estate syndications. 

Then there’s the tax treatment. Mortgage REIT dividends are not considered qualified dividends eligible for preferred tax treatment, but rather ordinary dividends and are taxed at the shareholder’s marginal tax rate. Therefore, the higher your tax rate is, the less you stand to profit. 

You can keep your REIT holdings in a tax-deferred retirement account to avoid having those REIT dividends added to your taxable income entirely while you’re still working however.

If you’re a lower- or middle-income worker entering retirement, consider mREITs as another way to diversify your income streams in retirement. But they come with plenty of volatility and risk, so don’t invest a huge portion of your portfolio in them. 

If you’re younger and or have higher earnings, mREITs’ high yields may seem attractive. But you can often find better returns and tax treatment from other investment opportunities.

How to Invest in mREITs

One advantage to mREITs is how easy they are to buy and sell. You can invest with your regular brokerage account, buying and selling shares like any other company. 

And that goes not just for your taxable brokerage account, but also for your tax-sheltered accounts such as IRAs, 401(k)s, and HSAs. That makes REITs extremely simple to add to your retirement portfolio for tax-deferred investing. 

If you’re new to investing, check out the best brokerage accounts for beginners. Most allow you to buy and sell mREITs at will.

Mortgage REIT FAQs

I get it: you work hard for your money, and investing it can make your teeth rattle. But the better you understand what you’re investing in, the better you’ll sleep at night — and the better your odds of earning strong returns. 

What Are Some Examples of mREITs?

A few examples of mortgage REITs include Annaly Capital Management Inc. (NLY), New Residential Investment Corp. (NRZ), Starwood Property Trust (STWD), and Arbor Realty Trust (ABR). 

I’m not saying you should invest your life savings in them, just listing a few examples. Do your own homework when evaluating REITs, and check out our list of the best REITs on the market

What’s the Difference Between an mREIT & an Equity REIT?

Equity REITs own properties directly. They buy buildings, renovate or maintain them, and often manage the day-to-day operations. 

Mortgage REITs own loans secured by real estate. That includes mortgage loans, but also potentially commercial real estate loans. Most mREITs don’t own any real estate directly, although some hybrid REITs own both properties and property-secured debts.

How Are mREITs Taxed?

Like all REITs, mREITs pay no corporate taxes, except on retained earnings. 

You as a shareholder do pay taxes on any dividend payouts you collect, typically at your ordinary income tax rate. You’ll receive a 1099-DIV from the REIT, and you enter the income on Form 1040 Schedule B

Final Word

By taking advantage of bond spreads that are fairly predictable and offering liquidity to the real estate market, mREITS offer an opportunity for investors to hand over their funds to experts who can play both the bond and real estate markets to turn a profit.

Just make sure you look beyond those juicy dividend yields, no matter how tantalizing they first appear. By looking at an mREIT’s balance sheet, cash flow statements, earnings reports, and past performance, you can get a good sense of whether the company is worth investing in — and whether you can stomach the risk.

G. Brian Davis is a real estate investor, personal finance writer, and travel addict mildly obsessed with FIRE. He spends nine months of the year in Abu Dhabi, and splits the rest of the year between his hometown of Baltimore and traveling the world.