For Risk-Tolerant Clients, Solve Yield Quagmire with These REITs

The 2021 tale of yield woe continues and shows little sign of relenting into year-end. Fortunately, there are avenues advisors can turn to to juice the income profiles of client portfolios.

Within the alternative assets space, real estate is a favored income destination and while many clients are familiar with the most basic interpretations of this asset class, there are more ways to skin the real estate cat and some of those come with the big yields clients crave.

Consider mortgage real estate investment trusts (mREITs). mREITs are providers of real estate financing and that capital is delivered to borrowers via buying or originating mortgages and mortgage-backed securities (MBS). The companies' income is generated by the interest earned on those investments.

In other words, this isn't a complex business model, so mREITs are easily explained to income-starved clients and speaking of the income proposition, the VanEck Mortgage REIT Income ETF (NYSEARCA:MORT) sports a tidy 30-day SEC yield of 7.98%.

MORT a Magnificent Income Idea

MORT yielding roughly 10-year Treasuries do isn't unusual nor is it a 2021-specific scenario. Indeed, mREITs have rich histories of out-yielding many fixed income assets.

“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,” according to VanEck research.

Now, here comes the part where advisors can add value in the mREIT conversation. As noted above, many clients probably aren't intimately familiar with mREITs. As such, they aren't familiar with the risks that come along with this asset class.

“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,” adds VanEck. “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.”

There's value in that lesson because clients are often seduced by high yields without considering the risks that come can come along with those big yields.

While the high dividend nature of mREITs isn't a free lunch, the asset class has some other perks clients will benefit from, including high return potential and diversification benefits owing to historically low correlations to standard equities.

One More Value Add Opportunity for Advisors

REITs have special tax treatment, derived by paying out a specific percentage of net income in the form of dividends. As such, an asset like MORT may have some complexities involving return of capital (ROC) that clients will need help navigating.

“Real estate investment trusts (REITs) are one type of investment that typically have distributions containing a component of ROC,” notes VanEck. “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.”

Another way of looking at mREITs and MORT is that clients will love the income-generating capabilities of these assets while advisors are sure to enjoy the opportunities to connect with clients while helping them navigate an unfamiliar asset class.

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