The Federal Reserve is keeping normal interest rates near zero, so investors who need income have to look elsewhere. Many are attracted to mortgage REITs. While strategies differ, a mortgage REIT generally borrows money at low short-term interest rates and lends it long-term in mortgages that pay higher yields. Some lend the money directly or through mortgage brokers. Others buy mortgage securities of various types. They might try to buy them at discounts or further leverage their purchases or both. The best-known of these are Annaly Capital and Hatteras Financial.
While mortgage REITs generate very high yields when everything is going well, they don’t hold the yields long term. They cut their dividends, and their share prices drop significantly. That happened recently, and Jeff Gundlach of DoubleLine Funds says he expects more dividend cuts in the near future and recommends avoiding mortgage REITs for now.
“I sold all MBS REITS a few months back,” said Gundlach, whose main bond fund has beaten 99 percent of rivals this year, according to data compiled by Bloomberg. “I figured the dividends were going to be cut.”
The trusts are lowering payouts because prepayments are increasing on government-backed securities, most of which are carried by REITs above 100 cents on the dollar, which means “their yields are going lower,” Gundlach said.