Historically, mortgages have been able to generate a nice income for the holder of the mortgage, save for the 2008 debacle (which continues to date), in which debtors just walked away from their properties.
One of the most glaring risks of this type of investment is the illiquidity of a mortgage. If you want to get rid of it, you may be hard pressed to find someone interested in buying it at a reasonable price.
But with the real estate market bottoming, (and one can argue that it has not bottomed), there are once again opportunities to invest in that sector to generate income and long-term returns.
One way to do this is through the iShares FTSE NAREIT Mortgage REITs Index ETF (REM). Yes, I know it's a mouthful, but it can provide a pocketful of cash. REM seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the FTSE NAREIT All Mortgage Capped Index. It pays a dividend yield of 11.3%! That's not a typo: 11.3%
That being said, it does not come without risk. Lest we forget our Finance 101—to generate returns, we must take on risk. The more return we seek, the more risk we have to take.
REM has a standard deviation comparable to an equity index. So investing in it must be accompanied by a side of sedatives if you detest volatility. If you're a long-term investor and volatility tastes more like a side of bacon cheese fries after a full night of binge drinking, then this could be a good investment for you.
The key to the success of these two companies, and the ETF for that matter, is in their ability to obtain low-cost financing to purchase residential and commercial mortgage-backed securities that produce an attractive income stream paid out through dividends.
There are certainly risks, however, such as the inability of the REIT to obtain financing, a deterioration of the quality of acquired assets, and an increase in pre-payment speeds caused by refinancing at lower rates. In the current environment, we think these risks are manageable.
Financing has been available (to worthy borrowers), the deterioration of assets is behind us, in our view, and we don't think rates will fall much further, so refinancing will be minimal.
Generally speaking, I wouldn't put a big chunk of grandma's retirement account in REM, but done tastefully, it could add some much needed income in an environment where yield is so hard to find.