Ahead of the policy committee meeting to be held next week, speculation of a rate hike is rife. There are many who expect a hike after a recent upbeat job report, improved inflation data and a rise in consumer spending levels.

Goes without saying, the real estate investment trust (REIT) sector, in particularly the mortgage REIT (popularly known as mREIT) segment, has started to worry. But instead of letting all the guesswork get on your nerves, think beyond funding costs and dig deeper into the operating mechanisms to pin down the impact of a rate hike on mREITs.

How are mREITs Placed?

Unlike Equity REITs that hold properties like shopping malls, office buildings and apartments and earn rents form their tenants, mREITs offer real estate financing through the purchase or origination of mortgages and mortgage-backed securities. They depend on short-term loans like repurchase agreements for their funding and earn profits from the spread between interest income on their mortgage assets and their funding costs. In short, generally mREITs borrow for short-term, lend for long-term and benefit from the spread, implying that they gain more when the yield curve becomes steeper.

Now, a yield curve becomes steeper when the gap between the short-term and the long-term rates increases, denoting that long-term rates are rising faster than the short-term ones, or that the short-term rates are falling and the long-term rates are rising. Since the second case is not applicable here considering the current short-term rate trend in the U.S., a steeper yield curve is essentially a sign of investors’ expectation of a rise in inflation or of solid economic growth.

This is because as the future value of an investment declines with rising inflation, investors end up demanding higher long-term rates to compensate for the lost value. Also, when the economy grows, demand for long-term capital increases, driving long-term rates higher.

And according to the latest data from the U.S. Commerce Department, the domestic economy is essentially experiencing a rise in inflation. The personal consumption expenditures index (PCE), a measure of inflation preferred by the Fed, climbed 1.3% in January from the year-ago level while the so-called “core” inflation, which excludes food and energy prices, saw a rise of 1.7%.

Well, the level seems closer to the Fed targeted 2%. This is all the more justified with Fed Vice Chairman Stanley Fischer recently proclaiming at an economic conference that "we're not that far away" from the desired inflation level, with stabilization of oil prices and the dollar.

mREIT Stocks to Buy Now

Against this backdrop, choosing the top-ranked mREIT stocks is likely to fetch decent returns. After a challenging 2015, these are already trading at a discount, allowing good entry points. And with decent dividend yield, they look all the more attractive.
 

American Capital Mortgage Investment Corp. (MTGE - Snapshot Report)

With an earnings surprise of 8.33% in the latest reported quarter, this Bethesda, MD-based mREIT currently has a Zacks Rank #1 (Strong Buy) and a dividend yield of 11.13%. The stock witnessed positive estimate revisions over the past 30 days with the Zacks Consensus Estimate increasing to $1.99 from $1.89 for 2016 and $1.83 from $1.80 for 2017.

Colony Capital Inc. (CLNY - Snapshot Report)

Another Zacks Rank #1 stock, Colony Capital also came up with a solid earnings surprise of 20.45% in the last reported quarter. It has a dividend yield of 10.08% and is also experiencing positive estimates revisions. Over the past 30 days, the 2016 Zacks Consensus Estimate for this Los Angeles, CA-based mREIT increased to $1.88 from $1.83.

Annaly Capital Management, Inc. (NLY - Analyst Report)

This New York-based mREIT that has a Zacks Rank #2 (Buy) also came up with encouraging results in the fourth quarter, delivering an earnings beat of 10.71%. Its Zacks Consensus Estimate has moved higher, now standing at $1.17 for 2016 against $1.13 earlier.

Moreover, over the past 30 days, the same for 2017 climbed to $1.06 from 99 cents. The stock also has a decent dividend yield of 11.73%. It has a Value Style Score of ‘B.’ According to our style score system, a stock with favorable Zacks Rank and a Zacks Value Style Score of ‘A’ (or ‘B’) is highly desirable.

Dynex Capital Inc. (DX - Snapshot Report)

This Zacks Rank #2 stock posted an earnings surprise of 8.70% in the latest reported quarter. It boasts a dividend yield of 14.70% and has a Value Style Score of 'A.' With the P/E trading at a discount of over 11% to the industry, this Glen Allen, VA- headquartered mREIT also remains our choice.

ZAIS Financial Corp. (ZFC - Snapshot Report)

Red Bank, NJ-based mREIT, ZAIS Financial has a Zacks Rank #2. In the third-quarter 2015, it reported an earnings surprise of 31.71% and presently boasts a dividend yield of 10.91%. The company’s 2016 earnings are estimated to grow 5.81%.