With interest rates at rock-bottom levels, where is an income investor to turn? Investment-grade corporate bonds are in the low 2% range, and even junk bonds pay miserly returns.
Fortunately, the real estate investment trust (REIT) sector is a fertile ground for finding juicy dividend yields. Two with exceptionally high dividend yields are in the mortgage REIT sector: Annaly Capital Management (NYSE:NLY) and AGNC Investment Corp. (NASDAQ:AGNC). Which one is the better buy?
Mortgage REITs are a different animal
First, a little background on mortgage REIT stocks, which are fundamentally different than all other REITs.
Most REITs will buy property and rent it out — think of Simon Property Group (malls), Kilroy Realty (offices), or Equity Residential (apartments). These stocks have a landlord-tenant model. Mortgage REITs don’t own properties — they own real estate debt. Annaly and AGNC invest in mortgage debt that is issued by Fannie Mae and Freddie Mac. This mortgage debt is guaranteed by U.S. government agencies, which means that despite the pandemic and borrowers in forbearance, Annaly and AGNC still get their principal and interest payments on time. An added bonus is that the Federal Reserve is buying billions of dollars’ worth of these securities every week in order to support the economy.
Early in 2020, the mortgage REIT sector had a rough ride as the COVID-19 crisis was beginning. Fears of a hard landing caused the financial markets to sell off, and this included the mortgage-backed securities markets. Like the entire mortgage REIT sector, Annaly and AGNC were beset by margin calls and forced to cut their dividends. The Fed stepped in and started buying mortgage-backed securities, which ended the crisis in the mortgage markets. Now that markets have settled, the mortgage REITs have returned to their normal business model.
Double-digit dividend yields are normal in this space
Both AGNC and Annaly have attractive dividend yields. With most stocks, when you see a high single-digit or low double-digit dividend yield, it is usually a sign of distress and that yield is too good to be true. For the mortgage REIT sector, double-digit dividend yields are normal. The mortgage REITs are able to generate those sort of yields because they use leverage to boost their returns, similar to the way a margin loan can boost the returns on your stock portfolio. The difference between the interest they earn and the interest they pay is the net interest spread.
The table below gives the most important statistics about the companies.
|Dividend Yield||Discount to Book||Net Interest Spread||Debt / Equity|
Both Annaly and AGNC are the leaders in the agency REIT space (as I hinted above, these are mortgage REITs whose debt is guaranteed by government agencies). The two companies are quite similar, although Annaly has slightly more credit risk than AGNC Investment. Annaly has the better yield as well as lower leverage. Annaly is trading at a 6% discount to book, while AGNC is trading at a 9% discount. Both companies have probably increased book value over the quarter, so those numbers are probably conservative.
It is hard to go wrong with either, and I have both stocks in my CAPS portfolio. I think at this point, you have to give the nod to Annaly due to its higher yield and lower leverage. That said, both are well-run companies that can give an income investor some yield in a pretty parched environment.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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