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I recently wrote two articles on the sensitivity of mortgage REITs to changes in interest rates as a result of requests from readers to explore this topic. The rationale behind the request was to determine the staying power of the dividends and the impact of the market value changes on the value of the various mREITs.

In the discussion streams on mREITs over the various articles I have read and written, the single largest concern that readers/investors have is dividend cuts as the yields are one of the motivating factors for investment in the sector. The two Harbors (TWO) dividend cut announced on Wednesday, September 11th will, no doubt, only serve to heighten this concern.

There is, however, another way to invest in the sector which creates a fixed stream of dividends: preferred stock.

Preferred stock is a level up the capital structure from common equity and, in most instances, has a fixed dividend rate. This dividend rate cannot be changed and is not subject to the volatility of the net interest spread or changes in the market value of the portfolio. As well, the preferred stock is paid before the common, so if there is a reduction in income, the preferred stock is paid and the common stock is forced to adjust its dividend to market conditions.

However, there is no such thing as a free lunch. An investment in the preferred stock of mortgage REITs will typically have a lower yield than the common equity. The reasoning is straightforward: a preferred stock investor is not an owner of the company and does not have the exposure to changing dividend rates. In other words, investors take a reduced yield as it is a known dividend. If the mortgage REIT falls on hard times, the dividend can also be deferred, although they are cumulative. If the preferred dividend is deferred, the common dividend is cut altogether. As well, preferred stock can be redeemed, typically at the worst time for investors, at the issue price after a fixed date (the optional redemption date). Redemption is a risk for investors as they may find their attractive preferred redeemed and have to reinvest those proceeds into lower yielding investments.

Using the largest mortgage REIT, Annaly Capital Management (NLY), as an example: the common stock currently yields 12.4%, while their series C preferred stock yields 7.48% - the difference of nearly 5% is the "cost" of stability. As well, on or after May 16, 2017, the REIT can redeem the issue at $25 a share - which affects realized yield if the issue is purchased above $25.

There are many popular mortgage REITs that have issued preferred stock (many this year due to low rates and demand for stable income products. Below is a table which contains many of the outstanding mortgage REIT preferreds and their details. Included in this table are: American Capital Agency (AGNC), Annaly Capital, Armour Residential (ARR), Colony Financial (CLNY), Dynex Capital (DX), MFA Financial (MFA), NewCastle Investment (NCT), and NorthStar Finance (NRF).

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Bottom Line: Investors who want higher yields but are wary of potential dividend cuts of the mortgage REITs should consider the preferred stock of mREITs. While the yield is not as high as the common equity yields, the preferred stocks cannot cut the dividend, creating a more stable yield alternative.

Source: Concerned About mREIT Dividends? Buy The Preferred Stock

Additional disclosure: This article is for informational purposes only, it is not a recommendation to buy or sell any security and is strictly the opinion of Rubicon Associates LLC. Every investor is strongly encouraged to do their own research prior to investing.