It's the continuation of a low-interest rate environment through mid-2015 that has mREIT investors feeling fine. The Fed has committed to keep interest rates low for at least another 2 ½ years. This environment benefits mortgage REITs as they generate income from the spread between the interest income on mortgage-backed securities and the costs of borrowing to finance their acquisition of mortgage-backed securities. Those who prefer owning a basket of mREITs over single selections may want to consider the iShares FTSE NAREIT Mortgage Plus Capped Index Fund (REM). This fund yields a generous 11.28%.
This fund is composed of 28 mortgage REITs, one industrial office REIT, and a small percentage in S-T securities. It has an expense ratio of 0.48%. I'd like to highlight REM's top 5 holdings.
% of Fund
Annaly Capital Management (NLY)
American Capital Agency Corp. (AGNC)
Two Harbors Investment Corp. (TWO)
MFA Financial Inc. (MFA)
Chimera Investment Corp. (CIM)
The largest holding in the fund, Annaly, is also the largest mREIT listed on the New York Stock Exchange. Interestingly, Chimera is a subsidiary of Annaly, so Annaly essentially accounts for over 26% of the REM ETF. It is important to note that virtually all of the investment securities owned by Annaly are guaranteed by U.S. Government agencies and have an actual or implied AAA rating. The company owns a combination of adjustable, floating, and fixed-rate mortgage backed securities.
American Capital Agency invests in agency securities where the principal and interest are guaranteed by a U.S. Government agency or a U.S. Government sponsored agency. Its asset mix is made primarily of fixed mortgages of 30, 20, and 15 year durations.
Two Harbors focuses on investing in residential mortgage-backed securities. It manages a portfolio of Agency and non-Agency mortgage-backed securities. Its primary shareholder objective is to deliver dividends, while its secondary priority is to achieve capital appreciation.
MFA Financial invests on a leveraged basis in residential mortgage-backed securities. MFA's mortgage-backed securities are mostly secured by pools of hybrid and adjustable-rate mortgage loans on single-family homes. The mortgages consist primarily of hybrids, ARMs, and 15-year fixed loans.
Outlook for mREITs
The low-interest rate environment is continuing, so I would expect the mREITs to continue to perform well for at least the next 2 ½ years. The spreads between interest income and costs should remain favorable for continued positive income generation. This should keep the generous yields intact. The mREITs as a whole are fairly valued. REM's net asset value per unit is $15, which is slightly below the current price of $15.03. This should still allow for some price appreciation while cash distributions are collected. Even if the price remains stagnant, who will complain about collecting an 11% yield?