REMICs vs. collateralized mortgage obligations (CMOs)
In truth, a REMIC is commonly considered to be a collateralized mortgage obligation (CMO). While ultimately these two financial instruments are both forms of a mortgage security, or mortgage loans that are bundled together and sold as investment instruments, there are some important differences between them.
In particular, CMOs were created to give investors a specific form of cash flow instead of just passing through the borrowers' principal and interest payments in the same way as a REMIC.
In addition, a REMIC is exempt from federal tax on a corporate level while, on their own, CMOs are not. This is why, even though CMOs are a separate entity from REMICs, they often exist within REMICs for tax purposes. They do so to avoid double taxation during each taxable year.
REMICs vs. real estate investment trusts (REITs)
While a REMIC and a real estate investment trust (REIT) are both methods of investing in real estate without going through the hassle of buying and maintaining a property. In addition, REITs aren't taxed on a corporate level; their investors have to pay income tax on any dividends they receive. But the differences all but stop there. In truth, these two investment vehicles could not be more different.
As we have discussed, REMICs pool together various mortgage loan assets into a mortgage-backed security, break them down into bonds, and sell the investments to interested investors.
A real estate investment trust, on the other hand, will invest in a portfolio of real estate assets, such as apartment buildings, retail spaces, or office spaces. Companies will then lease these spaces, which will generate income for the REIT, and any income will be paid out as dividends to investors who own shares of the REIT.
Recently proposed changes to REMIC rules
Although this type of securitization vehicle already has its own unique set of taxation rules, it's worth noting that REMICs have been making headlines in recent years because of proposed changes to the existing REMIC rules. We've laid them out below so you have a better idea of what changes could be on the horizon.
The Real Estate Mortgage Investment Conduit Improvement Act of 2009
The REMIC Improvement Act of 2009 was first introduced by Congress in order to ease the restrictions on commercial mortgage loans that had been securitized by REMICs. As it stands, the borrower may not be allowed to make certain changes to their property, because any changes to the value of the underlying collateral would affect the REMIC.
The proposed law would allow borrowers to make improvements to their properties. It also includes a declaration that does not allow these improvements to be considered prohibited transactions by the IRS. In addition, any income generated by those improvements will be treated as though it was income received from qualified mortgages.
The bill has moved on to the Committee for Banking, Housing, and Urban Affairs, but it has not made any further progress as yet.
The CARES Act
Under the CARES Act, which was first signed by former President Trump in 2020 and then extended by President Biden, homeowners struggling financially during the COVID-19 pandemic have been granted increased forbearance protections.
However, since forbearance changes the structure of the underlying collateral, again, these protections would have an effect on the REMICs too. However, the IRS has provided a safe harbor to ensure that any modifications to the mortgage loan obligations arising from the COVID-19 pandemic will not jeopardize the status of any REMICs or have any negative tax implications.
The bottom line
At the end of the day, mortgage securities and the REMICs who issue them are generally considered to be a fairly safe investment option, particularly for those investors who are averse to risk. Their payment structure and underlying collateral make them an attractive addition to a portfolio. Still, if the 2007 financial crisis taught us anything, it's that no investment is ever completely without risk.
With that in mind, if you've been thinking of investing in mortgage-backed securities, it's a good idea to do some research on real estate mortgage investment conduits first. You can use this post as a guide to help you get started. However, if you have more specific questions regarding REMICs and how they work, it might not be a bad idea to reach out to a financial professional.