A real estate mortgage investment conduit, also known as REMIC, is a pool of mortgages that have been divided up into various mortgage-backed securities for investors to purchase. The mortgages are divided into different classes of risk, coupons and maturity rates. Real estate mortgage investment conduits belong to a category of securities known as synthetic investments, which take one kind of investment vehicle and combine it with another. In this case, property mortgages are bought and repackaged as bonds. The same process also happens with collateralized mortgage obligations (CMO), only with different payout and risk categories involved.
In a real estate mortgage investment conduit, risk and interest rates vary with each individual security. The primary risk when investing in these pools is that the mortgage backing the purchased security will be paid off too quickly, thus denying the investor interest rates he or she would have otherwise received. This is called a risk of prepayment. Prepayment, although not an investor's best-case scenario, isn't catastrophic: the investor simply receives back his or her principal with less interest earned on it than hoped. The upside is that the returned principal is now free to be reinvested into another security. Prepayment is more likely in a low housing market, when more homeowners may opt to refinance their loans.
A real estate mortgage investment conduit is similar in concept, although different in function, to a CMO. A CMO, like a real estate mortgage investment conduit, is a mortgage pass-through investment vehicle. Mortgages are pooled together, divided and distributed as bonds. With CMOs, however, different categories of investors receive interest from mortgage-backed securities. According to a CMO ranking system, certain investors receive interest payments before others. In exchange for being paid first, though, those investors shoulder more of a risk burden than those who receive payments after them.
The luxury of a real estate mortgage investment conduit is that the investor has a wide variety of securities to choose from, which affords some ability to choose what risk level in which to invest. An investor who wants a relatively secure return on investment may opt to buy a low-coupon bond through a real estate mortgage conduit. Low-coupon bonds return less interest than high-coupon bonds, but they are more likely to offer the investor a full return on investment. Other investors who can bear more risk may opt for high-coupon real estate mortgage conduit bonds. These bonds have a higher risk of prepayment, and may represent mortgages with a higher rate of refinancing, but if successful, they can offer greater interest rates and greater profits.