Rising Interest Rates Burn Mortgage REIT ETFs

ETF Trends

Mortgage real estate investment trust ETFs offer very attractive double-digit yields. Investors, though, are learning that the robust payouts come with risks, especially in a rising rate environment.

The iShares Mortgage Real Estate Capped ETF (REM)  has a 14.73% 12-month yield. The Market Vectors Mortgage REIT Income ETF (MORT) comes with a 11.05% 12-month yield.

The mortgage REITs hold a pool of home loans bundled into securities, provide a large rate of return to investors by borrowing money and leverage their portfolios by up to a factor of eight, writes Arash Massoudi for Financial Times.

However, as yields on benchmark 10-year Treasuries rose from the May low of around 1.63% to its current 2.71%, mortgage REIT values have plunged. REM is down 15% over the past three months while MORT showed a 14.3% decline. [Higher Rates May Push REIT ETFs Into Red for Year]

The higher interest rates diminish the chances that homeowners will refinance their mortgage rates. Consequently, the securities have declined in value to reflect the rising risk of holding high duration bonds over a longer period.

“None of these companies wanted to cut dividends so they got more complacent about their exposure to rising rates,” Michael Widner, analyst at KBW, said in the article.

Many mortgage REITs did not anticipate the sharp spike in interest rates, revealing their complacency and lack of hedging preparations.

“I think mortgage REITs have glossed over the risks,” Brad Golding, managing director at Christofferson, Robb & Co, said in the article. “There are investors that are not sophisticated enough to understand what is going on here and, eventually, whether it is spreads blowing out or higher short-term rates, there are going to be real problems.”

iShares Mortgage Real Estate Capped ETF

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For more information on real estate investment trusts, visit our REITs category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own REM.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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