MORT: Question & AnswerCoulter Regal, CFA, Associate Product ManagerSeptember 20, 2021
In the prolonged low rate environment, many investors have had to expand their search for yield to opportunities beyond that of traditional corporate or government debt. Mortgage REITs are one lesser-known, income-generating investment that have garnered attention. This blog is intended to answer frequently asked questions on mortgage REITs and VanEck’s Mortgage REIT Income ETF (MORT).
What is MORT and what are mortgage REITs?
A real estate investment trust, or REIT, is a type of security that invests in real estate or real estate related assets and typically trades on major market exchanges similar to stocks. Mortgage REITs, or mREITs, are a type of REIT that provides financing for real estate by buying or originating mortgages and mortgage-backed securities (MBS) and then earns income from the interest on these investments. Mortgage REITs give investors a simple way to tap into the real estate market without having to own, operate, or finance properties themselves. Investors have historically found value in mREITs primarily because of their history of high dividends. VanEck’s Mortgage REIT Income ETF (MORT) offers investor’s comprehensive exposure to the U.S. mortgage real estate investment trust market. For more information on VanEck’s Mortgage REIT Income ETF (MORT), visit the product webpage here.
Why are yields on mortgage REITs high?
Dividend yields offered by mortgage REITs have historically been higher than yields on more traditional income oriented assets like Treasury securities or corporate debt. However, like any high yielding security, the attractive income potential of mREITs is reflective of additional potential risks. Mortgage REITs tend to employ leverage and/or take on credit risk in non-agency MBS and commercial mortgage loans and securities to increase yield. Beyond leverage and credit risks, high sensitivity to changes in interest rates, prepayment risk, and general real estate market risk are all factors embedded in mREITs yields. Investors attracted to the yield potential of mortgage REITs must also weigh the risks associated with such an investment.
Another contributing factor to high yields, is favorable tax treatment and a requirement for REITs to distribute the vast majority of their income to shareholders. To qualify as a REIT, the trust must distribute at least 90% of its taxable income to shareholders. In turn, REITs typically don't pay any corporate income taxes because their earnings have been passed along as dividend payments. The unique structure and tax advantages of REITs, along with the additional risk exposures mentioned above, translates into higher yield potential than what might be earned in traditional fixed-income markets.
What type of mREITs does MORT provide exposure to?
There are dozens of publically traded mortgage REITs available in the market all with varying ranges of exposures in terms of residential or commercial and agency or non-agency investments. Some mREITs are focused exclusively on purchasing high credit quality agency mortgage-backed securities while others focus more on commercial mortgage origination or lower credit quality non-agency investments. There are also many mortgage REITs that invest in several, or even all, areas of the mortgage real estate market in non-static portions that fluctuate overtime. Because of the wide range of exposures and non-uniform reporting metrics, it can be difficult to accurately measure the breakdown of these exposures within MORT. However, because MORT provides broad exposure, investors should generally expect to gain exposure to most or all areas of the mortgage REIT market through MORT.
What is the difference between mortgage REITs and equity REITs?
As mentioned earlier, mortgage REITs invest in and own mortgages or mortgage back-securities and income from the interest on these investments. Equity REITs, on the other hand, acquire and manage actual properties for the purpose of generating rental income. Mortgage REITs and equity REITs are similar in that both are required to distribute at least 90% of their income to shareholders, rather than retain that income for growth. Equity REITs tend to be more common than mortgage REITs, though mortgage REITs have historically offered higher dividend yields than equity REITs.
Does MORT Distribute Return of Capital?
Return of capital (ROC) is a payment received from an investment that is not considered taxable income, but instead reduces a shareholder's cost basis and may be recognized as a capital gain at the final sale of the investment. Real estate investment trusts (REITs) are one type of investment that typically have distributions containing a component of ROC. This is due to special tax treatments for REITs, like depreciation adjustments, that reduce taxable income without reducing the amount of cash available for distribution. Due to MORT’s underlying exposure to REITs, a portion of the fund’s distribution may be considered ROC as the fund distributes all of its net cash received from investments (including ROC) to investors. Investors may receive a “Section 19 notice” accompanying a distribution from MORT which estimates the portion of MORT’s current and fiscal year-to-date distribution comprising return of capital. Please view MORT's Tax Documents and visit VanEck’s Tax Center for more information on the portion of return of capital paid by MORT.
How do mortgage REITs fit into a portfolio?
Mortgage REITs have unique characteristics that may make them attractive to both income and growth investors. Their high dividend potential may be used to help provide a yield boost for those investors searching for additional income, or in more aggressive long-term growth portfolios for their potential high total return. An allocation to mortgage REITs may also add much desired diversification benefits to a portfolio thanks to historically low correlation to equities and traditional fixed income instruments. However, as mentioned previously, mREITs come with elevated risk compared to other traditional income investments and should be considered in an allocation decision.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities/financial instruments mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of 3rd party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
An investment in the Fund may be subject to risk which includes, among others, mortgage REITs, equity securities, financial, small- and medium-capitalization companies, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, issuer-specific changes, non-diversified and concentration risks, all of which may adversely affect the Fund. Small- and medium-capitalization companies may be subject to elevated risks.
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Authored byCoulter Regal, CFA
Associate Product Manager