Seeking Alpha
Long only, long-term horizon, medium-term horizon
Profile| Send Message|
( followers)  

Summary

  • DRIP investing in mREITs can be extremely profitable in the long term with the high yields mREITs pay in dividends.
  • Taxes should be factored in to fully appreciate DRIP income projections.
  • Historical performance and projections of future income analyzed.

Dividend Reinvestment Plans (DRIP) are usually free ways to reinvest your dividends back into a stock you own so that dividend income streams can increase over time. mREITs are high yielding stocks that usually pay upwards of 10% per year in dividends and are candidates for extremely profitable long-term DRIP plans that can leave you with huge increases in value and dividend income in a relatively short time frame. This article will attempt to explain some of the considerations of such a plan.

DRIP explained

Dividend reinvesting plans are set up by a broker or by the company on request. They are usually free to set up and the dividends are reinvested on the pay date without the usual trading fees. Trading fees can add up - 10 years of dividend reinvesting quarterly would cost 400$ if executed with 5$ trades. DRIP plans would save you those fees.

A downside is you have to pay taxes on the dividends you receive even if they are reinvested. This means you have to have income to pay those taxes that doesn't come from the dividends. Regular IRA or 401K accounts let you only pay taxes later on when you start tapping into the nest egg. Roth IRA accounts become more reasonable the longer you are in a DRIP program and the smaller your current income compared to your future income.

Another downside is determining the cost basis for tax purposes. You will have to keep a record of the price and quantity of shares purchased if your broker does not do it for you.

DRIP programs take away the prospect of market timing your purchases of shares. If you think you can time the market, it may be in your best interest to not do a DRIP program, pay the trading costs, and try to time your purchases when share prices are depressed.

Power of DRIP investing in mREITs

Below is a table of the projected returns on a $10,000 investment in either MORL, ARR, NYMT, or NLY in a 10-year time frame using DRIP. Share prices and dividends are assumed to be stable in this time frame (with mREITs you can rest assured this will not be the case, they have volatile share prices and changing dividends, although it's possible these can even out if averaged over time).

StockYieldEnd Stock ValueYearly Dividend IncomeTotal Taxes paid if within 15% bracketTotal Taxes paid if within 25% bracket
MORL19.37%$66297.13$12841.75$8444.57$14074.28
ARR13.79%$39399.82$5433.24$4409.97$7349.96
NYMT13.62%$38164.67$5198.03$4224.70$7041.17
NLY10.21%$27406.28$2798.18$2610.94$4351.57

As you can see, having a high dividend stock like MORL in a DRIP program can increase your money over 6 fold in a 10-year time frame and give you a yearly income that's bigger than your initial investment after that. Taxes paid are a hit on total return that becomes substantial in the long run as that is money that could have been invested throughout the time period.

DRIP only works well if reality is somewhat close to or better than the projections one can make. The table below looks at real returns if $10,000 each of MORL, ARR, NYMT and NLY were bought on December 1st 2012, immediately enrolled in a DRIP program, and held until the end of May 2014.

StockTotal Stock ValueYearly Dividend IncomeTotal Taxes Paid if within 15% tax bracketTotal Taxes paid if within 25% tax bracket
MORL$12121.48$2347.93$510.68$851.13
ARR$7465.62$1029.51$259.00$431.68
NYMT$13823.31$1882.73$475.29$792.15
NLY$9330.26$952.62$245.24

$408.74

The effect of management choices and dividend changes can be seen in the different returns between NYMT, NLY, and ARR. The power of diversification within the mREIT sector and high dividends from the 2x leverage can be seen in MORL. It really does matter which mREIT you pick for your DRIP plan. NYMT is the cream of the crop in this time frame as its stock price has risen a bit and the dividends have stayed the same.

Another aspect to look at is how NLY has performed over the life of the stock as this gives us a good look at real history in time frames where DRIP can show its compounding power. The table below shows the real returns of a DRIP program started at NLY's inception on the 8th of October 1997 with a $10,000 investment. This is also compared with a few other favorite DRIP investing names (JNJ, O).

StockDate# of shares at endValueYearly Dividend IncomeTotal Taxes Paid if in 15% tax bracket
NLY8 OCT 1997 - 29 May 20145512$63,387$6252.46$10767.07
O8 OCT 1997 - 29 May 20142320$100,024$5081.88$5822.30
JNJ8 OCT 1997 - 29 May 2014478$48,338$1338.40$283.87 (qualified dividend)

The historical analysis of a DRIP program in NLY shows that large returns over time have precident. This strategy resulted in a 25% annual return factoring in taxes. NLY did not beat O in total returns, but the annualized dividend payout at the end is larger (not much consolation as you could just switch your O stock to NLY and get an annualized dividend of over $10,000).

Using DRIP programs with mREITs is not a "set it up and walk away" type of investment. There should be monitoring of financial news in order to see if the business model still makes sense. Inverted yield curves or sudden spikes in interest rates can deteriorate the mREIT business model.

mREITs set up for DRIP have the possibility of quickly increasing the value of your assets and the yearly income you can receive after you end DRIP. Initiating DRIP for MORL, NYMT and a few of the other mREITs - namely CYS, AGNC, MTGE, TWO, and perhaps WMC with a long term investing horizon can be a relatively quick way to drastically increase your assets. (If the 2x leverage of MORL is a risk you dont want, MORT is essentially the same thing without the leverage) Investing in mREITs may not be as predictable or stable as an O or a JNJ; the dividends and share price of mREITs will fluctuate. However, if you can handle the risk, this may be the best way to grow your account value and create a large dividend income stream.

Source: Dividend Reinvestment Plans For Mortgage REITs

Additional disclosure: I have a DRIP program initiated in NYMT and may purchase O with the intent of enrolling it in a DRIP program over the next 72 hours.