Mortgage REITs have often been recommended by brokerage firms as safe investments that generate consistent income. However, during the recent market turmoil the bottom has fallen out for many Mortgage REITs. For example, AGNC Investment and Annaly Capital are down over 50% in the last month or so, a way larger drop than the general equities markets. Another Mortgage REIT, AG Mortgage, is down 75%. Many of these mortgage REITs do not expect to be able to meet upcoming margin calls.
How did these mortgage REITs end up here? Well, first of all, a REIT is a real estate investment trust which is a security that invests in real estate directly either through properties or in this case, mortgages or mortgage-related bonds. The mortgage REITs listed above are publicly held and sold on exchanges. There are also what are called non-traded REITs which are often sold through broker-dealers and are not traded publicly. Mortgage REITs invest and own property mortgages. They also loan money for mortgages to real estate owners, buy existing mortgages and purchase complicated MBS (mortgage-backed securities). Mortgage REITs generate revenue by collecting interest on the mortgage-related products.
As reported widely this week, the Mortgage REITs often fund themselves by pledging bonds in return for cash in the repo markets. They are highly leveraged which in good times allowed them to pay dividends at higher yields than most bonds. Brokers often recommend to investors to reach for yield in low yielding time periods and many brokers sold Mortgage REITs to investors without fully disclosing the risks associated with them. In recent weeks, many Mortgage REITs found that the mortgage bonds they held dropped in value which triggered margin calls which then forced the Mortgage REITs to sell bonds into a falling market.