By Kathleen Martin
REITs have been in favor with dividend investors seeking income. In particular, favorable tax treatment makes REITs more desirable because of the requirement that 90% of income must be paid to trust unitholders. Investors know that management cannot withhold cash that must be paid through distributions by law. For this very reason, I suggest that sophisticated investors consider investing in REITs. I decided to take a look at the yield sustainability of a few of the most popular real estate companies. Please use my research as a starting point for your due diligence.
Annaly Capital Management Inc.'s (NYSE:NLY) principal business is to generate net income for distribution to investors from its investment securities and from dividends it receives from its subsidiaries. Annaly owns mortgage backed securities that are guaranteed by Ginnie Mae, Freddie Mac and Fannie Mae. These three government agencies provide guarantees to groups of mortgages and sell them as low risk bonds, similar to treasuries. Annaly mitigates market risk through its various subsidiaries which hold, trade and clear in the securities that represent its capital distributions.
Annaly trades on the New York Stock Exchange at around $17 per share. The year low is $14.05. The year high is $18.79. The price earnings ratio is 12:36. The annual dividend yield is 13.50%. The share price doesn't have wild price swings and the dividend distributions are generous.
As with any company that trades in Agency (Fannie Mae, Freddie Mac or Ginnie Mae) guaranteed paper, there is a risk that long term bonds may rally which would result in a flattening yield curve. This could be detrimental as leveraged loans became unattractive. In the third and fourth quarter of 2011, the cash liquidity in the market has dried up and investors continue to wait and see how asset coverage and cash flow are affected in a recessionary scenario.
The dividend paid on January 26, 2012 was $0.57, down from the dividends of $0.62, $0.65 and $0.60 for the three preceding quarters, respectively. As previously stated the stock price is not volatile and it is in between its year high and year low. It makes sense that the dividend will decrease this year, given the Fed's current position on interest rates. Still, the dividend would have to be cut in half at a lower stock price to put this investment in the unfavorable category.
Chimera Investment Corporation (NYSE:CIM) trades around $3, has a year high of $4.34 and a year low of $2.38. The price earnings ratio is 5:57 and earnings per share is $0.55. The dividend yield is 14.4%. Chimera is connected to Annaly by virtue of being a wholly owned subsidiary, managed by the Fixed Income Discount Advisory Company FIDAC, another wholly-owned subsidiary of Annaly Capital Management Inc. It invests in residential mortgage loans and real estate related securities and other asset classes. Unlike its parent, it does not invest solely in Agency guaranteed paper. It does invest in asset classes that are not subject to government guarantees. As such, it is able to achieve higher returns, should favorable market conditions be present. It distributes income from the gap in coupon rates on these instruments and the profit realized on the trading of these instruments.
The Federal Reserve expects the economy to continue to grow at a slow pace in 2012, but macro threats domestically and from abroad still call for caution as the European situation will impact the liquidity of U.S. fixed income instruments. Any further measures to ease inflation and stimulate the economy are going to result in near term rates remaining low. In present day, we are looking at a yield curve that may be going flat when all maturities have a similar yield. Chimera's comment on the market, which is from the parent Annaly Capital Management, states that there were three influences in the Treasury market that have worked to counteract each other: 1) The somewhat better than expected economic numbers which should have led to higher yields; and 2) the continued problems coming out of Europe and the short term/long term U.S. Treasury swaps that have driven down rates. These factors have been responsible for the 10-year Treasury trading in a 35 basis point range for the last 60 days of calendar 2011. Chimera decreased its dividend from the second quarter of $0.14 per share to $0.13 in the third quarter and to $0.11 in the fourth quarter. It is a trend that is expected to continue in 2012 as the fixed income strategies are not providing returns to continue to distribute double digit dividend yields.
Apollo Investment Corporation (NASDAQ:AINV) is an investment company that operates tangentially to REITs. It trades around $7.5, has a year high of $12.46 and a year low of $5.97. Its earnings per share is negative at ($0.36) and the dividend yield is 14.9%. Unlike the REITs mentioned here, Apollo is a leading provider of subordinated debt and equity capital to middle-market companies. However, much like a REIT, it generates income and capital appreciation through debt and equity investments and distributes the income to its shareholders. In my opinion, Apollo could and should make moves to gain more favorable tax treatment and partition some of its business into a trust to permit distributions. Indeed, its portfolio is comprised primarily of investments in subordinated loans and senior secured loans to private middle market companies. The quality of the companies it finances in its portfolio will determine the safety of the dividend. Apollo has several high quality consumer and corporate services companies in its portfolio and a few underperforming holdings. The asset mix is broad, everything from education to security services to healthcare. It has a good mix of subordinated debt, equity and preferred investments.
I am going against the grain here, and will submit that the earnings are not impressive, and, while the dividend yield is high, it has been consistent since 2009. The latest full fiscal quarter delivered both a disappointing earnings report as a result of the August capital markets rout. In its 2011 Annual Report the company said it expects short term volatility in the capital markets which will present opportunities for lending institutions like Apollo as traditional lenders will not be able to provide any service.
At this price, the dividend is steep but it is trading above its low and has an interesting and varied enough mix in its portfolio companies to take advantage of any bright spots in varied markets.
Armour Residential REIT (NYSE:ARR) trades around $7.15, has a year high of $7.99 and a year low of $5.40. There is no information on price earnings ratio, the earnings per share is negative at ($0.61). The dividend yield is 18.5%. Its dividend decreased from $0.12 in September 2011 to $0.11 in October 2011. Armour invests primarily in hybrid adjustable rate and fixed rate residential mortgage backed securities. A hybrid REIT owns both Agency and non-Agency mortgage backed securities. Its portfolio targets low duration assets that are highly liquid to reduce gross interest rate exposure in Agency securities. It only purchases traded instruments, not collateralized mortgage obligations.
Its January 19, 2012 update indicates a book value of $7.08 per share and estimates that taxable REIT income for the year 2011 will exceed dividends declared and paid. Dividends are paid monthly and were paid at the rate of $0.11 per share to Q1 2012.
Credit Suisse is quoted as saying that even though interest spread opportunities contracted during 2011, the returns on Agency instruments remain attractive by historical standards. Government actions should make for a more predictable return path than 2011. Hybrid/non-Agency REITs offer more attractive value for investors and the potential for more capital appreciation plus a more stable dividend outlook. With Armour's strategy and the stock trading near its book value, the dividend payout may remain the same but the share price will probably outperform its peers.
MFA Financial (NYSE:MFA) trades around $7.40, has a year high of $8.64 and a year low of $6.23. The price earnings ratio is 7:87, the earnings per share is $0.92 and the dividend yield is 13.80%. MFA is primarily engaged in the business of leveraged investment in a portfolio of hybrid and adjustable rate mortgage backed securities. A large portion of the portfolio is issued or guaranteed by the Agencies. To a lesser extent, it invests in high rated, high quality, hybrid and adjustable rate mortgage backed securities.
MFA will be paying an ordinary cash dividend on January 31, 2012 of $0.25 and special of $0.02 on the same date. The taxable income for 2011 will exceed the sum of the dividends paid to date and on the fourth quarter regular cash dividend. A REIT must distribute at least 90% of its estimated annual REIT taxable income.
Analyst estimates expect the stock to outperform the market while these estimates also expect dividends to increase approximately 10.5% in the upcoming fiscal year. MFA forecast earnings growth of approximately 3.31% this year. EPS is forecast at $0.24 in this quarter. The dividend on this REIT is safe for 2012.
American Capital Agency (NASDAQ:AGNC) trades around $29.00 has a year high of $30.76 and a year low of $22.03. The price earnings ratio is 4:76, the earnings per share is $6.11 and the dividend yield is 19.20%. The company was formed in 2008 to invest in guaranteed Agency securities. It pays quarterly dividends on net interest income which is the spread between the interest income earned on assets and the interest cost of borrowings and hedging activities. It funds its investments primarily through short term borrowings structured as repurchase agreements.
The third quarter update indicates that the net spread decreased from a high in the fourth quarter of 2010 from 2.58% to 2.46% in the second quarter of 2011 to 2.14% in the third quarter of 2011. The return on equity declined from 42.4% in the fourth quarter of 2010 to 20.4% in the third quarter of 2011.
American Capital Agency shows forecasts of 2.00% earnings growth in the next five years with earning forecast at $1.22 for the quarter ended December 30, 2011. It experienced a revenue growth of 115.6% in the previous year. The company has a limited operating history in comparison with the other companies mentioned herein. Either the share price or the dividend yield will diminish. The performance of either of these is based upon the performance of its cost of borrowing and hedging activities.
Dividend payouts are dependent upon the quality of the investments, the leverage and hedging activities each company employs. The share prices dictate the yield which rises as the share price falls. Double digit dividend yields can be red flags for the share price. In general, market pricing of the REITs is anticipating that long/medium term dividends may be lower. The spreads are narrowing and lower mortgage rates will make it easier to refinance high rate mortgages. This will reduce the value of some of the REITs existing investments and lower returns.