Why Mortgage REITs Are Only for Those Willing to Risk

NEW YORK (TheStreet) — Mortgage lenders have the greatest racket: Pay virtually nothing to borrow from savings and checking depositors, then lend at 4% or 5%. If only there were some way ordinary investors could do the same.

In fact, there is, through a type of mortgage-owning Real Estate Investment Trust suitable for investors willing to take more risk than they would with bank savings.

REITs are better known for owning actual real estate such as apartment buildings, malls and strip shopping centers. Those traditional "equity REITS" pass rental income on to investors. But a less well known variety called a mortgage REIT backs mortgages, passing to shareholders the profits from homeowners' monthly payments. Some operate like mutual funds, others as exchange-traded funds bought and sold like stocks. 

For yield-starved fixed-income investors, the attractions can be mouthwatering. Top payers such as iShares Mortgage Real Estate Capped EFT and Market Vectors Mortgage REIT Income ETF have yielded more than 12% over the past 12 months, according to Morningstar, the market-data firm.

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"Mortgage REITs have exploded in popularity in recent years, in part because their yields can be attractive," says Adam Zoll, an editor at Morningstar. At the end of 2013 there were 45 mortgage REITS listed on the New York Stock Exchange and Nasdaq, with a total market capitalization of $62 billion. That's a tiny slice of the fund and ETF markets, but it's growing fast.

Savvy investors know that high yields typically come with high risks, and that's definitely the case with mortgage REITS. The biggest is interest-rate risk, the same hazard that afflicts bonds. As interest rates rise, older securities that pay less lose value. Mortgage rates have been unusually low for years, helping boost returns on mortgage REITS. But most experts think rates will rise gradually. Many of these REITs amplify their interest-rate risk with high levels of borrowing, or leverage.

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