Looking to invest in some real estate? For the average investor, real estate can seem a bit out-of-reach financially. However, mortgage real estate investment trusts (REITs) provide one option for the typical investor to get involved with large-scale real estate investments. REITs are unfamiliar to many people but they’re actually pretty simple once you get down to the basics. Here’s a quick and easy guide to mortgage REITs and how you can become an investor.
What Are Mortgage REITs?
Real estate investment trusts (REITs) are companies that own real estate for the purpose of investing. REITs can be one of two types: equity REITs or mortgage REITs. While equity REITs own and operate properties and collect any profits from those properties (rental income, capital gains from property sales, etc.) mortgage REITs mostly lend money to real estate owners and operators.
How Do REITs Work?
Mortgage REITs are created when a company has most of its assets and income tied to real estate investments. Shareholders involved with a REIT get at least 90% of the company’s taxable income each year – in many cases, 100% of the taxable income is given to shareholders to avoid corporate taxable income. Basically, shares of REITs work in a similar way to stocks: shareholders of REITs get a pro-rata share of the profits and economic benefits that are earned through their real estate. In the case of mortgage REITs, those profits are typically the interest earned from their borrowers.
With REITs, shareholders can trade their shares similar to how they can trade stocks. Shareholders also have to pay taxes on the dividends and capital gains they receive from their shares of REITs. However, if a REIT experiences tax losses it cannot pass those on to its investors.
Pros Of REITs
The main advantage of mortgage REITs is that they make investing in large-scale real estate more accessible to the average investor. However, there are also some additional perks to investing in mortgage REITs, such as:
- Diversifying your portfolio
- Higher returns
- Relative stability
- Good long-term performance
- Tax advantages
Cons Of REITs
Mortgage REITs can be a great way to invest. However, there are some disadvantages to mortgage REITs that investors need to consider, including:
- Higher risk with mortgage REITs compared to equity REITs
- Subject to interest rates
- Figuring out REIT taxation can be difficult at first
- Possibility for loss
Choosing A Mortgage REIT
There are over 1,000 REITs in the U.S. (about 10% of which are mortgage REITs), so investors have many options for which REITs they want to get involved with. Mortgage REITs involve a level of risk, just as with any type of investment. One of the main risks with mortgage REITs is the fact that they are subject to interest rates and credit risks. However, you can minimize this threat by choosing a mortgage REIT that makes smart financial moves to counteract those risks.
A good mortgage REIT has the following qualities:
- Derivative strategies: The mortgage REIT uses tactics to minimize risk such as securitized mortgage investments and dynamic hedging techniques.
- Transparency: All information, data and financial statistics are available to borrowers.
- Leadership: Most successful REITs have an executive management team that includes a board of responsible, respected and well-known real estate and/or business professionals.
- Specializing: Profitable REITs often specialize in lending to owners of a certain type of property, whether that is apartment buildings, industrial facilities or health care facilities.
Mortgage REITs can be very confusing for the beginning investor. It’s a good idea to consult a financial advisor before becoming a shareholder with any mortgage REIT. An advisor can help you research the best REITs and figure out the best time to begin investing based on market prices.