The Mortgage REIT hype
Mortgage real estate investment trusts have created a loyal following with the potential for high yields appealing to income seekers. Per The Motley Fool:
There are two main types of mortgages that REITs invest in: agency mortgage REITs and non-agency residential mortgage REITs.
These REITs invest almost entirely in mortgages or mortgage-backed securities that are guaranteed by federal agencies such as Fannie Mae. While it is true that these mortgages are guaranteed and have no default risk, this makes the interest rates on the mortgages themselves extremely low, so in order to provide the kinds of returns that investors demand, they use a ton of leverage (sometimes up to 10%).
Non-agency residential mortgageREITs
These mREITs invest in mortgages that are not guaranteed by federal agencies, and they carry higher risks of default than their agency-guaranteed counterparts. So, while this does mean there's somewhat of a higher risk, the underlying mortgages can pay significantly higher interest rates, and therefore do not require such a high use of leverage.
So which is best?
While most mortgage REITs are risky, some are riskier than others, so the specific one you choose should depend largely on your personal risk tolerance. Perhaps the best strategy to reap the high yields of REITs is to buy more than one, preferably with different types of mortgages and leverage in their portfolios. This way, if one REIT with significant non-agency exposure has a rough quarter, the others in your portfolio should help to balance out the effects.