Real estate investment trusts, or REITs, are often a great source of passive income as the names in this sector are required by law to distribute at least 90% of their taxable income in the form of dividends.
This usually leads to stocks yielding well above the average yield of the S&P 500 index, which is 1.3% at the moment. In fact, it isn’t uncommon to find shares of REITs trading with very high dividend yields, sometimes in the double-digit range.
Of course, along with high yields can come high risk. This is especially true for investors who are looking to own shares of mortgage REITs. These trusts purchase mortgages and then use the monthly mortgage payments to distribute dividends. Names in this industry often borrow money to acquire mortgages. They then profit off the difference in the rates.
With the Federal Reserve telegraphing to the market that they intend to raise interest rates several times this year and next, investors of mortgage REITs need to be extremely diligent in the names that they choose to invest in.
This article will examine three mortgage REITs that we feel are among the best in the industry, including:
- AGNC Investment (NASDAQ:AGNC)
- Annaly Capital Management (NYSE:NLY)
- PennyMac Mortgage Investment Trust (NYSE:PMT)
Mortgage REITs: AGNC Investment (AGNC)
American Capital Agency, or AGNC, was founded in 2008. The mortgage REIT focuses its investment capital on residential mortgage pass-through securities. The trust’s portfolio also includes agency mortgage-backed securities, or MBS, on a leveraged basis, collateralized mortgage obligations, or CMO, as well as non-agency mortgage-baked securities. AGNC generated revenue of $1.3 billion in 2021 and is valued at $7.8 billion today.
By using leverage in its business, AGNC is able to purchase more mortgages and create a larger stream of income. In a rising interest rate, AGNC is likely to feel some pain as the spread could be lower.
The good news is that interest rates will likely not rise in dramatic fashion. With rates near 0% today, rates might not breach even 1% by the end of 2022 even with four rate hikes this year. It is possible that the transition to a higher rate environment will be gradual, making the trust’s business less volatile.
Most of AGNC investments are in the area of fixed-rate agency MBS. The trust’s portfolio largely consists of mortgages with close to 30 years until maturity. This gives AGNC decades to collect income from its assets that are backed by government-sponsored enterprises. In this way, AGNC’s income stream is more secure than the typical mortgage REIT. AGNC benefits from geographic diversification as the counterparties to some assets are based in the European Union.
Investors should be aware that AGNC has cut its dividend several times over the past few years, including in 2020, 2019, 2016, and 2015. There is some risk for diminishing dividend distributions.
That said, with a high-risk business often comes a high dividend yield. AGNC is no exception as the stock yields 9.7% as of the most recent close. This is nearly 7.5 times the average yield of the market index. AGNC also happens to be one of a handful of stocks that pays a monthly dividend, with the trust operating this way since November of 2014. Monthly dividend payments help spread income out over the full year instead of the traditional quarterly payments.
Annaly Capital Management (NLY)
Annaly invests in and finances residential and commercial assets, including agency MBS, non-agency residential mortgage assets, and residential mortgage loans. The $11.3 billion trust generates annual revenue of $1.1 billion.
Unlike most mortgage REITs, Annaly has a variety of other income sources besides the interest on mortgages. The trust is involved in loan origination, commercial real estate, and securities as well. In addition, Annaly is in the business of providing financing to private equity-backed middle market companies and acts as a broker dealer.
This level of diversification is beyond what most other names in the industry have, which should help to protect the trust’s business when interest rates are raised. We believe that Annaly’s diversification could help protect the dividend during economic hardships.
And, as is likely to be the case, Annaly could prove to be more successful at weathering the rising interest-rate environment that is likely to take place this year and next. The multiple businesses providing income that are not interest-rate sensitive should help to at least offset some of the weakness from lower spreads.
Even so, Annaly isn’t immune to dividend cuts either. Shareholders saw their dividend payments slashed 17% in the summer of 2019 and then 12% during the worst of the Covid-19 pandemic in 2020.
For those willing to assume the risk of owning a mortgage REIT, Annaly does offer a dividend yield that is above 11% currently. This is more than eight times the average yield of the S&P 500 index.
Mortgage REITs: PennyMac Mortgage (PMT)
Like the others in this article, PennyMac Mortgage purchases residential mortgage loans and mortgage-related assets. The trust was founded in 2009 and is externally managed by PNMAC Capital Management, which is a wholly-owned subsidiary of PennyMac Financial Services (PFSI). The trust is on the smaller side with a market capitalization of $1.7 billion.
PennyMac Mortgage is one of the more unpredictable mortgage REITs in our coverage universe. Annual revenue results have swung wildly over the past few years. This is largely due to the trust not having significant competitive advantages compared to other REITs in the industry. That said, PennyMac Mortgage could see its business improve given the total addressable market for the industry.
There are some positive points in the trust’s favor. PennyMac Mortgage is the largest correspondent aggregator, which should lead to higher sales of mortgage servicing rights. This should provide some tailwinds for the trust.
PennyMac Mortgage pays a very high yield of 10.6% as of the most recent close. This is more than eight times the average yield that the market index is paying investors. This is also one of the higher yields that the trust has provided in recent years.
Like the other discussed here, PennyMac Mortgage has a history of dividend cuts. The last one took place in the early portion of 2020, but this was mostly due to the impact from the pandemic. Unlike the other names discussed in this article, however, PennyMac Mortgage quickly raised its dividend the very next quarter. One quarter later and the dividend was back to its pre-Covid-19 level.
Dividend cuts are common in this area of real estate, but PennyMac Mortgage managed to raise its dividend back to levels seen prior to 2020 two quarters after slashing its distribution. We feel that investors should take this as a positive sign for the trust.
Final Thoughts
Mortgage REITs aren’t the safest of investments as they often rely on factors largely outside of the control. In all likelihood, interest rates are going higher in 2022 and possibly in 2023 as the Federal Reserve tries to control inflation.
Mortgage REITs could see a decline in the spread as a result. Thankfully, interest rate hikes should be gradual and still will be below typical levels.
If so, then dividends from mortgage REITs could be maintained, allowing for the collection of very high yields. For investors willing to take the risk of such an investment AGNC, Annaly, and PennyMac Mortgage could be good options to be added to the portfolio.
On the date of publication, Bob Ciura did not have (either directly or indirectly) positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Bob Ciura has worked at Sure Dividend since 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. His articles have been published on major financial websites such as The Motley Fool, Seeking Alpha, Business Insider and more. Bob received a bachelor’s degree in Finance from DePaul University and an MBA with a concentration in investments from the University of Notre Dame.