DIV 203Lesson 4 of 90 of 9
Mortgage REITs
REITs that own loans instead of buildings, and why their yields are so high.
What you’ll learn
- How mortgage REITs earn money from the spread between borrowing and lending
- Why they use so much leverage, and what that does to their yields
- Why book value per share is the number to watch
- Why a 15% yield has often come with a shrinking share price
Mortgage REITs regularly appear at the top of high yield stock lists, paying 10% to 16% a year. They’re REITs, but they don’t own a single building. They own loans. Understanding how they work explains both the yields and why many long-term holders have been disappointed.
How they make money
A mortgage REIT (mREIT) works like a leveraged bond fund. It buys mortgage securities paying, say, 5.5%. It funds them mostly with short-term borrowing, often through repurchase agreements (“repo”), at, say, 4.3%. The 1.2% spread looks thin, so it borrows a lot.
Agency and commercial
| Type | Owns | Examples | Main risk |
|---|---|---|---|
| Agency mREITs | Home mortgage bonds guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae | AGNC, Annaly | Interest rates and spreads, not defaults |
| Commercial mREITs | Loans on office, hotel, apartment and other commercial properties | Several large lenders | Borrowers defaulting, especially on office loans |
The agency guarantee means homeowner defaults rarely hurt agency mREITs. But the guarantee says nothing about the price of the bonds, and that’s where the trouble comes from.
What goes wrong
- Rising short-term rates raise the borrowing cost and squeeze the spread.
- Widening spreads between mortgage bonds and Treasuries knock down the value of the bonds they own, and with 7× leverage, a small drop becomes a big hit to book value.
- Prepayments: when rates fall, homeowners refinance and pay off high rate mortgages early, so the REIT has to reinvest at lower yields.
- Margin calls in a panic can force sales at bad prices. In March 2020 several mREITs were forced to sell, and some slashed or suspended dividends.
Watch book value, not just the yield
Mortgage REITs mark their securities to market, so they report a book value per share every quarter: the equity behind each share. Over long periods, many agency mREITs have seen book value per share drift lower while paying very high dividends, cutting those dividends several times along the way. Annaly even did a 1-for-4 reverse stock split in 2022 after years of decline. Shares tend to trade near book value, so a shrinking book value usually means a shrinking share price.
That’s the same pattern you’ll meet with high yield option funds: a big payout funded partly by the shareholders’ own capital. Try it here with a 16% distribution against a strategy that really earns 10% a year:
Live figures
| Ticker | Name | Yield | Pays | 1Y total return | 5Y total return | 1Y price change |
|---|---|---|---|---|---|---|
| AGNC | AGNC Investment Corp. | 16.65% | Monthly | -1.5% | +8.3% | -14.0% |
| NLY | Annaly Capital Management, Inc. | 16.42% | Quarterly | +0.8% | +6.3% | -12.0% |
| O | Realty Income Corporation | 6.07% | Monthly | -6.1% | +8.6% | -11.0% |
| VNQ | Vanguard Real Estate Index Fund ETF Shares | 3.61% | Quarterly | +1.2% | +5.6% | -2.5% |
Check your understanding
4 questionsHow does an agency mortgage REIT mainly make money?
What does 'agency' mean for mortgage securities owned by REITs like AGNC?
Why is book value per share so important for a mortgage REIT?
A mortgage REIT yields 15% but its share price and book value have fallen steadily for years. What's the likely total return picture?
Related lessons
This lesson is for education only and isn’t financial, investment or tax advice. Tickers are used as examples of how things work, not as recommendations. Figures marked as live come from Dividend Duel’s market data and change daily. See our disclosure.