From the Wall Street Journal

A few years ago, real-estate investment trusts that bought and sold residential-mortgage securities were a dying breed. Today, they are one of the hottest REIT sectors in the industry.

Of nine new REITs that have applied to sell stock in initial public offerings so far this year, seven are REITs that will invest in mortgage-backed securities, according to Dealogic Inc. The value of the offerings totals $2.6 billion, the largest amount devoted to mortgage REITs since 2009, when a flurry of investment companies set up REITs to scoop up battered commercial mortgage-backed securities.

The current batch of mortgage REITs will dabble in the residential market, at least initially, to take advantage of strong investment demand for the high-yielding securities.

The contenders include Pacific Investment Management Co., a unit of Allianz SE and one of the world’s largest bond investors, which plans to sell $600 million in shares of Pimco REIT Inc. Other offerings include a $500 million deal by American Capital Mortgage Investment Corp. and a $300 million offering for Putnam Mortgage Opportunities Co.

Many mortgage REITs went out of business during the real-estate crisis because they were virtually locked out of the credit markets, making it hard to refinance debt and make loans to borrowers.

A number of money managers have started funds to invest in mortgages in the past year, but those investments target large institutional investors. The mortgage REITs will target retail investors and consumers who are looking for an alternative to a plain-vanilla bond fund. At the same time, mortgage REITs that principally invest in agency mortgage-backed securities have raised at least $6.6 billion in equity since December, according to a recent report by Barclays Capital.

“There are investors … who want to buy into these kinds of investment vehicles who don’t have access” to a large bond fund because the minimum investments are very high, said Ron Sturzenegger, managing director and global head of real-estate, gambling and lodging investment banking for Bank of America Merrill Lynch.

The growing interest in mortgage securities reflects perceptions that prices for current securities—which have been rising in recent months from the distressed levels reached during the financial crisis—will continue to move higher in the years ahead.

At the same time, interest rates set on new mortgages in the future are expected to be higher than current levels, in part because private banks are expected to play a more significant role in the mortgage market while the role of government-supported Fannie Mae and Freddie Mac likely will be reduced. Some economists argue that the presence of Fannie and Freddie in the market keeps mortgage rates artificially low.

“We believe the current level of government involvement in the U.S. residential-mortgage market is not sustainable and that, over time, agency support may be significantly reduced and replaced by private capital,” Pimco said in its IPO filing last week. This “presents an attractive opportunity for us to implement our business objective.”

To be sure, while mortgage overhaul is likely to curtail Fannie and Freddie’s influence at some point, it remains uncertain exactly how long that will take.

“The government has been moving very cautiously as to not interrupt a large market and any … proposal will probably take some time to develop,” says Calvin Schnure, vice president of research-industry information at the National Association of Real Estate Investment Trusts, or Nareit. “There’s not any quick solution.”

REITs were established in 1960 to give individuals a convenient way to invest in income-producing real estate. The investment vehicles, which typically focus on distinct areas of real estate, such as offices, retail properties or apartments, are required to pay at least 90% of their taxable income out as dividends.

Yield-hungry investors have gobbled up REIT stocks during the past two years because they offer higher dividend yields than other financial stocks and U.S. Treasurys. But dividend yields on residential-mortgage REITs have been especially large, averaging 14.6% as of Monday, compared with 3.5% for all REITs, according to Nareit.

Mortgage REITs have high dividend yields partly because the managers use high leverage, which can boost returns. The REITs use low-rate, short-term debt to finance their bond purchases.

“With … attractive mortgage yields and low financing costs, we are able to achieve a very good return even while paying the costs of substantial hedging to protect against interest-rate increases,” says Scott Ulm, co-chief executive of Armour Residential REIT Inc. in an interview.