Investors are likely familiar with the standard Real Estate Investment Trusts, or REITs. Most REITs own physical real estate, lease the properties to tenants, and derive rental income which is used to pay dividends.
But there is a different set of REITs that investors may not be as familiar with: mortgage REITs. These REITs do not own physical properties, but rather buy mortgage securities. You can see all 173 publicly-traded REITs here.
Mortgage REITs typically have much higher dividend yields than standard REITs, but this does not necessarily make them better investments. For example, Orchid Island (ORC) is a mortgage REIT, with an extremely high dividend yield of 16.8%. It is one of 405 stocks with a 5%+ dividend yield, and is one of the highest-yielding stocks on the list.
Plus, Orchid Island pays its dividend each month, which makes it even more attractive as a dividend stock. It is one of only 34 stocks with a monthly dividend. However, the outlook for mortgage REITs is challenged. Orchid Island’s dividend yield does not appear to be sustainable.
This article will discuss why income investors should not be lured by the siren song of Orchid Island’s 16% dividend yield.
Business Overview
Whereas traditional REITs own a portfolio of properties, mortgage REITs are purely financial entities. Orchid Island is an externally-managed, specialty finance company. It invests in residential mortgage-backed securities, either pass-through or structured agency RMBSs.
An RMBS is a debt instrument that collects cash flows, based on residential loans such as mortgages, home-equity loans, and subprime mortgages. Mortgage-backed securities are an investment product representing a basket of pooled loans.
As investors saw first-hand during the 2008 financial crisis, mortgage-backed securities can be highly volatile. This is the first of many reasons why risk-averse income investors would be wise to steer clear of Orchid Island.
Mortgage REITs were among the biggest winners as interest rates were falling during the aftermath of the Great Recession. But, if the U.S. is about to enter a monetary tightening cycle, their performance could deteriorate.
