By Siraj Sarwar
At the beginning of 2007, the Dow Jones REIT Index was standing over 360. After the collapse of Lehman Brothers, the index dropped all the way down to 85. Since then, the real estate investment trusts gradually recovered. As of the time of writing, the REIT index was standing at 262.
While this is a great recovery, I think REITs still have substantial upside potential. A significant advantage of REITs is that they get special tax considerations which help them to pay substantial dividends. These stocks also offer investors an extremely liquid method of investing in real estate.
Mortgage REITs [mREITs] are a specific class of real estate investment trusts. Most of these companies do not directly invest in real estate, yet they provide financing for real estate developments by acquiring mortgage-backed securities. Therefore, their performance is strongly correlated with the rest of REITs. In this article, I investigated three less known mREITs that offer dividend yields of greater than 10%. These stocks are Apollo Residential Mortgage (NYSE:AMTG), Armour Residential (NYSE:ARR) and Two Harbor Investment (NYSE:TWO). It is worth to noting that these three mREITs have provided magnificent returns to shareholders in the last year.
Apollo Residential Mortgage invests in, finances and manages agency mortgage-backed securities [MBS], non-agency MBS and residential mortgage loans in the U.S. Recently, the company announced a quarterly dividend of $0.70/share for the fourth quarter, yielding at 13.74%. In addition, Apollo also announced a special dividend of $0.35/share, representing the company's strong financial health.
Furthermore, Apollo is a top dividend REIT stock according to Dividend Channel. The company displays both strong profitability metrics and attractive valuation metrics. For instance, the stock is trading with a price-to-book ratio of 0.80 and offers an annual dividend yield of 13.74%. On the other hand, the average stock in Dividend Channel's coverage universe yields 3.7% and trades at a price-to-book ratio of 1.9.
FED's low interest policy significantly helped the company's mortgage portfolio in the previous quarter. The company has increased its book value by more than 9% quarter over quarter. Apollo is likely to continue its book value appreciation as the housing market continues to improve. At the end of Q3, the company generated a net income of $2.91/share. On the negative side, it reported operating earnings of $0.67/share for the last quarter, far less than the dividend payments.
Apollo is one of the least known mREITs in the market, yet the company is offering one of the best yields. I think the company's special dividend perfectly sketches the financial health. The stock has a strong momentum, and returned about 50% in the last year.
ARMOUR Residential is another hybrid mortgage REIT. It primarily invests in the agency-fixed rate, adjustable rate and hybrid adjustable rate RMBS. The mREIT is externally managed by ARMOUR Residential Management. The company offers an enormous monthly dividend of $0.08 per share. Armour Residential is named as a top-yielding REIT by Dividend Channel. Armour shares display strong profitability metrics and eye-catching valuations. The stock is undervalued at present. With a price-to-book ratio of 0.90, it is trading at a discount to book value.
Armour supports a trailing dividend yield of 16.62%. The average stock in Dividend Channel's coverage universe yields 3.7% and trades at a price-to-book ratio of 1.9. Armour's three-year revenue growth rate stands at 30.9%. The company has an operating margin of 67.4%. On the negative side, the financial leverage of 8.12 is a bit high compared to the industry average.
The company has a strong MBS portfolio, which is diversified between adjustable rate, agency fixed rate and hybrid adjustable rate securities. In addition, Armour's constant pre-payment rate stood at 13.0%. The company generated an average yield on assets of 2.70%. Net interest margin stands at 1.82%. Using an average leverage of 8, the management successfully turned this tiny margin spread into a double-digit yield.
Two Harbors Investment invests primarily in residential mortgage-backed securities [RMBS]. The company seeks to offer attractive, risk‐adjusted returns over the long-term, mainly through dividends and secondarily by capital appreciation.
Currently, Two Harbors offers a gigantic quarterly dividend of $0.55 per share, yielding 13.86%. At the end of Q4, the company generated a return on book value of 47%. Its annual dividends stand at $1.71 per share. The company has invested in Silver Bay Realty Trust (SBY), which focuses on the acquisition, renovation, leasing, and management of single-family residential properties for rental income and long-term appreciation. Two Harbors contributed its portfolio of more than 2200 properties to Silver Bay, together with $50 million in cash. In return, it received 17.8 million shares of Silver Bay Realty Trust. That was a wise move as the current value of these shares is about $400 million.
Two Harbors is perfectly positioning itself for the challenging market conditions. The company has performed pretty well in the past and is likely to keep doing so for the next few years. The company's expense ratio is also trending down, thanks to increasing returns to scale. Fellow SA contributor, David White expects the company to pay a hefty special dividend. Two Harbors is a sensible addition to a dividend portfolio. Similar to Apollo, Two Harbors is also a strong momentum stock. It returned about 50% in the last twelve months.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Efsinvestment is a team of analysts. This article was written by Siraj Sarwar, one of our equity analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.