A great alternative to traditional low risk fixed income investments such as Treasury Bills, Bankers Acceptances, Bonds, and Term Deposits are Mortgage Backed Securities and Real Estate Income Trusts. They offer a greater potential rate of return while taking only a little bit more risk.
What is a Mortgage Backed Security?
Mortgage Backed Securities (MBS) are a type of fixed income investment that are secured (or backed) by one specific mortgage such as a large commercial property mortgage, or a group of residential mortgages offered by the same financial institution. The bigger the mortgage and the higher the interest rate on that mortgage, the higher potential payout from the Mortgage Backed Security.
Mortgage Backed Securities are similar to bonds because they can pay out regular payments, usually on a quarterly basis. Investopedia describes Investors of Mortgage Backed Securities as the person who is “lending money to a home buyer or business.” As investors we give our money to the bank and in exchange, the bank gives us an interest rate of return. The bank then lends out our investment money in the form of a mortgage, where they collect an interest rate from the mortgage borrower.
Mortgage Backed Securities eliminate the need for the bank to have capital because the bank is not lending out their own money. They lend out borrowed money from investors. Mortgage Backed Securities can be purchased directly on the market or indirectly through a Mutual Fund.
What is a Real Estate Investment Trust?
Real Estate Investment Trusts (REITs) differ from Mortgage Backed Securities because they invest both in Mortgages as well as directly in a Property. There are three types of Real Estate Investment Trusts. Equity REITs invest directly in properties, Mortgage REITs invest only in mortgages, and Hybrid REITs invest in both properties as well as mortgages. An example of the type of property that a Real Estate Investment Trust would invest in is a shopping mall or a luxury apartment building. The revenue paid out to investors comes from the rent that tenants pay.
Similar to Mortgage Backed Securities Real Estate Investment Trusts can be purchased directly on the market or through a Mutual Fund.
When choosing the type of Mortgage Backed Security or Real Estate Investment Trust it is important to know the duration of the investments, as well as the interest rate, and issuing company. If we are planning to hold the Mutual Fund over the long term we may look for a REIT or MBS that invests in 30 year mortgages. However, the interest rate is a crucial factor in our rate of return. We don’t want to have a long term mortgage that is locked into a low interest rate.
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