Investors Should Think Twice About Owning Mortgage REITs

mortgage_reitsMortgage REITs, unlike equity REITs, are a class of real estate investment trusts that concentrate their efforts on owning mortgage debt. By leveraging their investments, mortgage REITs are able to offer investors extremely enticing dividend yields. And in today’s yield-starved world, some investors reaching for yield may have found their way into mortgage REITs.

But long-term oriented investors, in my opinion, would be better off in a myriad of other investments. This is especially true for investors concerned about a future sustainable rise in interest rates. The following table illustrates why:

Historical mREIT returns
The FTSE NAREIT Mortgage REIT Index dates back to the early 1970s. In the table above, the two columns on the left (excluding the year column) show the yearly total returns of the index and the index value based on total returns. The two columns on the right show the yearly returns based on price movements of the index as well as the index value based on price alone.

Since the index’s creation, there has been an extreme loss of value in the price portion of the returns. More specifically, from inception through 2012, the index, based on price alone, lost 93.83% of its value. And 2013 hasn’t exactly been a banner year for mREITs. When looking month-by-month, one discovers the mREIT price index declined even further during the first nine months of the year, falling to 5.56 by the end of September (from 6.17 at the end of 2012). I am of the opinion that reliable and steady income is an extremely important feature of an investment portfolio. But principal protection should not be ignored. An investment with the kind of historical track record that mREITs have in destroying the principal value of one’s investment are simply not suitable for long-term oriented investors.

Yes, it is true that over the 41-year history of the FTSE NAREIT Mortgage REIT Index, the total return is positive. At first glance, the rise from 100 to 776.34 might seem fantastic. But there are two reasons this is not the case:

First, when calculating the compound annual return, you will discover an annual return of just 4.978% through September 2013 (was 5.125% at the end of 2012). Given the time period under consideration, a less than 5% annual return is, quite frankly, really poor. It compares to an 11.92% compound annual return for the FTSE NAREIT Equity REIT Index during the same time period. Even bond investors would have struggled to underperform mREITs during the same time period.

The second reason the total return on mREITs is underwhelming is that it assumes all distributions were reinvested. I have a hunch there are far too many investors putting money in mREITs in order to use the distributions to help pay the bills rather than reinvesting the distributions back into mREITs. Had investors replicated that strategy during the 41-year history of the FTSE NAREIT Mortgage REIT Index, the total return story would have been much worse.

I understand that past performance is not indicative of future performance and that with different time horizons, an investor’s experience with mREITs may be far better than the returns illustrated above. I also recognize that trading mREITs over shorter periods of time can be quite lucrative (today might even be that time). With that said, for investors with multi-decade time horizons who plan to use distributions from their investments to pay the bills, I don’t think taking the chance of owning mREITs as a buy-and-forget type of investment is worth it. This is especially true given today’s low benchmark interest rates (the recent rise notwithstanding), the leveraged nature of a mortgage REIT’s business, and the historical lack of principal protection that mREITs provided. Without a doubt, when thinking about multi-decade investments, I would much rather own long-term individual bonds, well-established dividend-growth common stocks, exchange-traded debt, and/or preferred stocks over mREITs.

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All trading carries risk. Views expressed are those of the writers only. Past performance is no guarantee of future results. The opinions expressed in this Site do not constitute investment advice and independent financial advice should be sought where appropriate. This website is free for you to use but we may receive commission from the companies we feature on this site.

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