Now that the housing market has shown some strength, investors seeking yield might consider buying mortgage real estate investment trusts, or REITs. But these are not straightforward investments and buyers could get burned if they don't understand what makes mortgage REITs tick.
Mortgage REITs, which invest primarily in mortgage bonds, although they trade like equities, should be thought of as part of your fixed-income portfolio, says Barry Taylor, financial planner with Integral Financial Solutions in San Francisco. As such, they have all the risks associated with fixed income.
Two main risks of REITs
"The risk with any fixed-income product is interest rate risk," Taylor says, and mortgage rates are rising. Over the past several months, shares of mortgage REITs have fallen as investors worry about the Federal Reserve's tapering of its bond-buying program.
"The other risk is quality risk," says Taylor. "A lot of mortgage REITs are in the junk-bond category and investors are getting paid to take the risk." Junk bonds typically pay a higher rate because there is a higher risk of default.
Open the hood, check for leaks
While higher yields may look attractive in this low-rate environment, investors need to do their due diligence before buying to really see what's in the REIT, says Taylor. Mortgage REITs could hold a lot of lower-quality debt with a higher risk of default. "The bottom line is that you should look at them more closely if the yield is higher."
"Small" bets for rich people
For wealthier investors who can afford to make a bet, Taylor would suggest putting aside a small amount for risky investments such as a mortgage REIT. "People are always looking for the big buy and more yield," Taylor says. "The key to any strategy is, don't bet the farm on it."
Keep up with your wealth and mortgages and follow me on Twitter @JudyMartel.