Pros and Cons of REMICs (Real Estate Mortgage Investment Conduit)

REMICs are Real Estate Mortgage Investment Conduits--special purchase vehicles that pool together mortgage loans and insurance on mortgage-backed securities. Special purpose vehicle is a limited corporate entity that investors can use it oder to reduce risks, generate bigger profits, lower their taxes and get around certain regulations. REMICs can be issued by either federally sponsored mortgage companies (Fannie Mae and Freddie Mac) or by private financial institutions. REMICs offer great advantages to the investors, but they also contain a few disadvantages investors should be aware of.

How REMICs Work

REMICs are primarily composed of residential and commercial mortgage loans. The REMIC managers take those mortgages, put them together in a pool of money. They then issue securities that represent the investors' stakes in their pool of mortgage funds. Investors can then invest those securities in secondary mortgage markets, finance their debt and/or sell them as assets. The investors can also choose to keep their securities for themselves and earn income from monthly distributions.

Advantages of REMICs

One of the key advantages of REMICs is their stability. Real estate securities are only as viable as the funds that back them. If the borrower who took out a mortgage that backs the security winds up going into a default, the security becomes worthless. Pre-paying the loan has the same consequences. REMICs, on the other hand, are composed of many different mortgage loans that are geared towards several different types of real estate. If one mortgage winds up in default, the REMIC has plenty of other mortgages to fall back on. While the value of the securities may drop, they will never fully disappear.

Another advantages of REMICs is flexibility. As mentioned in the preceding section, investors can use their REMICs securities in a number of different ways, allowing the investors to choose from a wide variety of investment strategies. They can even split their securities and try all the options at once and see which one offers the best results.

Still another advantage is the fact that REMICs are not required to retain any of the funds they pooled together for the purpose of collateralization. This means that investors benefit from the entire pool of funds rather than a portion of it, allowing REMICs to issue more securities and increasing the values of individual securities.

Disadvantages of REMICs

The key disadvantage of REMICs is that while a REMIC isn't subject to corporate taxes, the investors have to pay taxes on the profits they earn from their securities. Furthermore, they may be taxed on both state and federal level. While this allows investors to avoid double-taxation, it gives them little room to reduce their capital gains taxes.

Another noteworthy disadvantage of REMICs is that once the mortgage pool is set, it cannot be easily changed. REMIC managers have the right to trade component mortgages for similar mortgages and get rid of defunct mortgages, but other than that, REMIC will have to be made up of the same mortgages as it started with. This limits how much profit the investors can ultimately earn from REMIC securities, since there are only so many shares they can offer.

But perhaps the biggest weakness of REMICs has nothing to do with REMICs themselves. In the wake of the collapse of the housing bubble, real estate values plummet to historic lows, which undercut the values of securities. The ensuing wave of defaults and foreclosures further aggravates the problem. This will change once the real estate market rebounds, but until then, investors may well be better off putting their money elsewhere.

 

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