Investing in Mortgage REITs | The motley madman


Mortgage REITs, or mREITs, provide real estate financing by creating or purchasing mortgages or mortgage-backed securities. They are a critical component of the residential mortgage market, helping finance approximately 1.7 million homes each year. They also support the commercial real estate industry by providing loans to develop, acquire, reposition and own income-generating properties.

Here’s a closer look at the overall mortgage REIT market, the unique risks of the industry, and some interesting mREITs to consider.

Image source: Getty Images.

Understanding Mortgage REITs

Mortgage REITs are a sub-category of Real Estate Investment Trusts (REIT) which focuses on real estate financing. Entities buy or create mortgages and mortgage-backed securities, earning interest income on their investments. Some mREITs also charge loan origination and management fees. These factors make mREITs similar to financial stocks.

Mortgage REITs make money differently from others real estate investments. They make a profit on their net interest margin, which is the difference between the interest income generated by their mortgage assets and their financing costs. Mortgage REITs use a variety of funding sources to create and purchase mortgages and related securities, including common and preferred shares, repo agreements, structured finance, convertible and long-term debt and credit facilities.

MREITs use these sources of funding to acquire mortgage-related assets. Some mREITs will create loans that they hold on their balance sheets and sell them to other buyers, including government agencies, banks, or investors. In addition, mREITs buy mortgages and mortgage-backed securities. They collect the loan fees and interest generated by the mortgages, keeping what is left after paying the financing and operating expenses.

Here is an example of how mREITs work. Let’s say an mREIT raises $ 100 million in equity from investors to buy mortgages. It obtains an additional $ 400 million from other sources, at an average financing cost of 2%, which allows it to purchase $ 500 million in mortgage-backed securities.

If the loans had a weighted average yield of 3%, they would generate $ 15 million in interest income per year. Meanwhile, at a funding cost of 2%, it would have $ 8 million in annual funding costs, allowing mREIT to generate $ 7 million in net interest margin each year.

IRS guidelines for mREITs require them to distribute 90% of net income to shareholders through dividend payments, which explains the high dividend yields for most mREITs.

Risks of Investing in Mortgage REITs

Mortgage REITs are riskier than many other investments, including other REITs, as they face certain specific risks, including:

  • Interest rate risk: While changes in interest rates affect REITs as a whole, they have an even greater effect on mREITs, as changes in short and long-term interest rates can affect net interest margins by increasing financing costs and reducing interest income. Changes in interest rates can also affect the value of a mREIT’s mortgage assets, affecting its net asset value and the price of its shares.
  • Early repayment risk: Mortgage borrowers can refinance their loans or sell the underlying real estate. When this happens, it forces the mREIT to reinvest the loan proceeds paid back into the current interest rate market, which could be lower than the existing mortgage rate.
  • Credit risk: MREITs focused on commercial mortgages may face credit risk if borrowers default.
  • Rollover risk: Residential mortgage REITs tend to hold long-term mortgages and mortgage-backed securities. However, they often finance these purchases with shorter term loans since short term interest rates are generally lower than long term rates. This financing strategy creates a risk of turnover. The mREIT must obtain financing at attractive rates to renew the loans as they fall due.

3 mortgage REITs to consider in 2021

There are nearly two dozen mREITs focused on real estate finance and 18 others focused on the commercial mortgage industry. Most underperformed the S&P 500 in recent years due to fluctuating interest rates. However, a few mREITs stand out as strong performers in this volatile industry:

Major Mortgage REITs


Asset type

Market capitalization

Dividend yield

Arbor Real Estate Trust



$ 2.7 billion


Hannon Armstrong Sustainable Infrastructure Capital



4.6 billion dollars





$ 1.8 billion


Data source: Ycharts and Google Finance. Market capitalization and dividend yield until October 17, 2021.

Here is an overview of the major mortgage REITs.

Arbor Real Estate Trust

Arbor Realty Trust is an mREIT that finances commercial real estate. It focuses on providing back-to-back loans on multi-family properties, although it also finances student housing, land, healthcare facilities, offices, single-family rentals and other types of properties.

The real estate finance company has three business platforms:

  • Loan arrangement on the balance sheet: Arbor takes out the loans it holds on its balance sheet.
  • Government Sponsored Business (GSE) / Agency Loan Creation: The REIT issues small loans ($ 1 million to $ 8 million) which it sells to Fannie Mae, Freddie Mac, the Federal Housing Administration and other agencies.
  • Maintenance: Arbor provides service for multi-family loans mainly held by GSEs.

Arbor’s business model provides him with multiple sources of income. MREIT generates long-term recurring cash flow from service fees, escrow income and net interest income. It also generates one-time origination fees. This strategy gives it an advantage over mREITs that focus only on making money through the net interest margin.

Its diverse operating platform and multi-family focus have enabled it to generate fairly stable profits in all market cycles. Arbor recorded its ninth consecutive annual dividend increase in 2021. This is remarkable since mREIT’s dividends have historically fluctuated due to the impact of interest rates on their net interest margin.

Hannon Armstrong Sustainable Infrastructure Capital

Hannon Armstrong is a unique mREIT. It is the first US public company focused solely on investing in climate solutions by providing capital to companies in energy efficiency, renewable energy, and other sustainable infrastructure markets.

Hannon Armstrong generates both investment income and fees. It uses investor capital and other sources of finance to make debt and preferred equity investments in a range of climate-positive businesses and projects. It makes these investments on its balance sheet. Its investment portfolio generates a net investment margin for the company as long as the gross return on assets exceeds its interest charges. The company also generates fee income by titling investments and advising its clients.

The company’s climate-focused financing strategy was successful. Hannon Armstrong has paid a stable and growing dividend and has generated above-market total returns in recent years. Growth is expected to continue as the company has a large portfolio of investment opportunities due to the acceleration of the transition to sustainability. The tendency leads Hanno to estimate that he can increase his distributable profit per share at an annual rate of 7 to 10% until 2023 while increasing his dividend per share at an annual rate of 3 to 5%.


iStar has taken an innovative approach to financing commercial real estate over the years. He helped start the adoption of the use mezzanine capital to finance real estate investments in the 90s. In the 2000s, iStar began to focus on improving the net rental market. More recently, the company has focused on land leases. He created a specialized REIT Safehold (NYSE: SR) to drive this strategy and is currently the investment manager and largest shareholder of Safehold.

A land lease, as the name suggests, is a lease on land under a structure. Through Safehold, iStar provides financing to commercial real estate developers and owners by acquiring land under a building and leasing it out, providing it with a very stable income.

In addition to its investment in Safehold, iStar still holds investments in its traditional financing strategies. However, this slows down the end of these businesses. While Safehold has grown as a percentage of iStar’s portfolio (it was 39% at the end of 2021), its legacy loan portfolio has shrunk from 14% in 2020 to 11% in 2021. Meanwhile, iStar is exploring the sale of its net lease. assets, which represented 36% of its portfolio.

The focus by iStar on expanding its land rental business through Safehold has paid off. The value of the company’s equity per share has steadily increased as Safehold has grown. This strategy has also enabled iStar to regularly increase its dividend. It benefits from the growing cash flows generated by the management and ownership of Safehold, as well as those generated by its historical businesses.

Mortgage REITs Offer Higher Dividends With Higher Risk

MREITs can generate a large net interest margin when there is a large spread between short-term interest rates (where they borrow) and long-term interest rates (where they lend). Unfortunately, the spread usually does not stay wide for long, which is why mREITs tend to be very volatile. Due to this risk, mREITs are not always the best option for income-seeking investors as their high returns fluctuate wildly. However, there are a few interesting mREITs worth considering, as their differentiated business models help insulate them from the overall volatility of the industry.


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