Ben Bernanke Just Handed Investors Dividend Yields up to 17%
If REITs were players’ pieces on a Monopoly game board, then they all just drew the equivalent to an “Advance to Go, Collect $200” card.
Real estate investment trusts — well-loved by investors for their income-producing yields — had a tough time in 2008. Real estate and mortgage lending were imploding at the time, and given that REITs primarily invest in income-producing properties and mortgage loans, the liabilities being assumed by real estate investors of any kind were nothing less than tremendous.
There was something brewing beneath the surface, however, that has set up near-perfect conditions for income-producing real estate investments now.
What’s that? An economy rebuilding itself fast enough to support a revival in real estate’s rental and lending business, but an economy with such fragile growth that the Federal Reserve wouldn’t dare scoot interest rates up one iota. One of Federal Reserve Chairman Ben Bernanke’s present fears is giving borrowers any reason to scurry away from any of the new, and much-needed, activity in the real estate market.
For two more years, at least
Better still, there’s a new batch of good news for REIT investors. Last week, in an out-of-character move, Mr. Bernanke telegraphed his long-terms plans by making it clear the Fed wasn’t planning on raising interest rates until 2014, at the earliest.
The upside of the announcement significant: REIT managers were already borrowing on the cheap and investing that borrowed money at a much better rate of return. Now these same REIT managers have an exact idea of how long they can continue to borrow money for next to nothing and serve up strong margins.
It’s a clarity investors rarely see in the stock market, but more important, it’s a potent opportunity in particular for mortgage REITs, or mREITs for short.
Picks of the litter
mREITs are simply a variety of real-estate investment trust focusing entirely on buying/funding mortgage loans. Though conventional real estate trusts that own or operate malls and apartment buildings are enjoying the benefit of cheap borrowing rates, the spread between today’s ultra-low interest rates and current mortgage lending rates are abnormally high. That puts mREITs in a proverbial sweet spot.
The company serving as the gold standard in the mREIT business could arguably be Annaly Capital Management (NYSE: NLY). It’s got a whopping 13.6% dividend yield, yet doesn’t require its shareholders to take on a great deal of risk to reap that return. In fact, it may offer far less risk than the average REIT, or the average stock for that matter. How? Annaly has made good on its commitment to only owning government-backed securities, which means it takes on no real credit risk… theoretically anyway.
Annaly’s not the only game in town though. And, considering how neither Annaly shares nor the dividend itself have proven to be impervious to the market’s bearish swings, investors may want to consider alternative ways to tap into this gift from Ben Bernanke.
Chimera Investment Corp. (NYSE: CIM) is one of them. With a yield of 14.4%, it’s comparable to Annaly. Yet, Chimera actually boasts a slightly more reliable dividend history. The irony? Chimera is managed by the Fixed Income Discount Advisory Company (FIDAC), which is a wholly-owned subsidiary of Annaly Capital Management.
Still, the approach Chimera takes is different than Annaly’s. Where Annaly leans toward government-backed securities, Chimera tends to hold riskier assets that don’t always have U.S. government backing. The higher (perceived) risk translates into a slightly higher reward.
Resource Capital Corp. (NYSE: RSO) is another name income-hungry investors may want to mull. It offers one of the biggest dividends of all within the REIT world right now.– a hefty 17.2% yield. The flipside is that Resource Capital, compared to Annaly, is almost at the other end of the spectrum when it comes to risk. Its portfolio holds quite a bit of commercial real estate securities, mezzanine debt and even equipment leases.
In other words, where Annaly is almost a pure residential mortgage holding where the federal government is more than happy to shoulder the guarantee, Resource Capital wades in corporate waters where government agencies generally don’t get involved. That’s part of the reason for the higher dividend yield — greater perceived risk.
Just for the record though, Resource Capital’s dividend history isn’t nearly as checkered as the economy’s recent swings might lead you to expect. It offered a quarterly dividend of $0.41 per share in 2007, and now it’s a still-respectable $0.25 — though the yield is much greater now than it was then.
As a kicker, both Chimera and Resource Capital trade at or under their book value.
Risks to Consider: While the Federal Reserve has effectively committed to a federal funds rate of 0.25%, this doesn’t necessarily mandate that mortgage lending rates will continue on at their relatively high levels. Indeed, the fed funds rate has been where it is now since the end of 2008, yet 30-year mortgage loan rates have fallen from more than 5.0% then to less 4.0% now. Each time mortgage loan rates sink, the wide margins that make mREITs so profitable end up taking a hit.
Action to Take –> Investors could justify taking on pieces of all three of the stocks mentioned above. Of the three, though, Resource Capital may be the top pick. Though its assets lack the federal government’s backing, that implied guarantee is rarely needed or used. Between its significantly greater dividend yield and its involvement in corporate America rather than consumer America, it’s actually an indirect way to invest in the U.S. economic engine while simultaneously driving very good income.