Income is a scarce commodity these days, and that has investors looking for yield in some lesser-traveled areas of the market. And that includes mortgage REITs (mREITs).
Even after months of rising yields, the rate on a 10-year Treasury is a paltry 1.6%. That’s well below the Federal Reserve’s targeted inflation rate of 2%, meaning that investors are all but guaranteed to lose money after adjusting for inflation.
The story isn’t much better with many traditional bond substitutes. Taken as a sector, utilities yield only about 3.4% at current prices, according to data compiled by income-focused index provider Alerian, and traditional equity real estate investment trusts (REITs) yield only 3.2%.
If you’re looking for inflation-crushing income, give the mortgage REIT industry a good look. Unlike equity REITs, which are generally landlords with brick-and-mortar properties, mortgage REITs own leveraged portfolios of mortgages, mortgage-backed securities and other mortgage-related investments.
In “normal” economic times, mortgage REITs have a license to print money. They borrow money at cheap, short-term rates, and invest the proceeds in higher-yielding longer-term securities. A steep yield curve in which longer-term rates are significantly higher than shorter-term rates is the ideal environment for mREITs, and that’s precisely the scenario we have today.
Mortgage REITs are not without their risks. Several mREITs took severe and permanent losses last year when they were forced by nervous brokers to make margin calls. Investors worried that the COVID lockdowns would result in a wave of mortgage defaults, leading them to sell first and ask questions later. And many have a history of adjusting the dividend not just higher, but lower, as times require.
But here’s the thing. Any mortgage REIT trading today is a survivor. They lived through the apocalypse. Whatever the future might hold, it’s not likely to be as traumatic as a once-in-a-century pandemic.
Today, let’s take a good look at five solid mortgage REITs that managed to survive and thrive during the hardest stretch in the industry’s history.
Data is as of April 21. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price.
Annaly Capital Management
- Market value: $12.3 billion
- Dividend yield: 10.0%
We’ll start with the largest and best-respected mREIT, Annaly Capital Management (NLY, $8.80). Annaly is a blue-chip operator with a $12 billion-plus market cap that has been publicly traded since 1997. This is a company that survived the bursting of the tech bubble in 2000, the implosion of the housing market in 2008 and the pandemic of 2020, not to mention the inverted yield curves and nonstop Fed tinkering of the past two decades.
Annaly was hardly immune to last year’s turbulence. But able to skate by the turbulence of last year due to large part to its concentration in agency mortgage-backed securities (MBSes), or those guaranteed by Fannie Mae and Freddie Mac. Investors were confident that, no matter what unfolded, mortgages backed by government-sponsored entities were likely to get paid.
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At current prices, Annaly yields 10% on the nose, which is about average for this stock. In its two decades of trading history, Annaly has yielded as much as 22% and as little 3% – in part because of price variance, but also because NLY isn’t shy about making dividend adjustments in boom and bust times. But it always seems to come back to the 9% to 10% range.
Still, if you’re new to mortgage REITs, Annaly is a good place to start.
- Market value: $9.3 billion
- Dividend yield: 8.3%
Along the same lines, AGNC Investment (AGNC, $17.44) is a solid, no-drama income option.
Take a minute and say “AGNC” out loud. It sounds like “agency,” doesn’t it?
That’s no coincidence. AGNC Investment specializes in agency mortgage-backed securities, making it one of the safest plays in this space.
For most of AGNC’s history, the stock has traded at a premium to book value. This makes sense. AGNC can borrow cheaply to juice its returns, and we as investors pay a premium to have access. But during the pits of the pandemic, AGNC dipped deep into discount territory. That discount has closed over the past year, but shares remain about 2% below book value.
The yield is a very competitive 8.3% as well. That’s a little lower than some of its peers, but remember: We’re paying for quality here.
Starwood Property Trust
- Market value: $7.3 billion
- Dividend yield: 7.6%
For something a little more exotic, give the shares of Starwood Property Trust (STWD, $25.38) a look.
Unlike Annaly and AGNC, which both focus on plain-vanilla single-family home mortgage products, Starwood focuses on commercial mortgage investments. Starwood is the largest commercial mortgage REIT by market cap with a value north of $7 billion.
Approximately 60% of Starwood’s portfolio consists of commercial loans, with another 9% in infrastructure lending and 7% in residential lending. And unlike most mortgage REITs, Starwood also has a property portfolio of its own, making up about 14% of the portfolio. This makes Starwood more of an equity REIT/mortgage REIT hybrid than a true mREIT, though clearly the business leans heaviest toward “paper.”
This time last year, Starwood’s property portfolio had its points of concern. As a commercial mortgage REIT, it had exposure to hotels, offices and other properties hit hard by the pandemic. But as life gets closer to normal by the day, those concerns are evaporating. And frankly, they were always overstated. Starwood runs a conservative portfolio, and the loan-to-value ratio for its commercial portfolio is a very modest 60%. So, even if delinquencies had become a major problem, Starwood would have been able to liquidate the portfolio and safely be made whole.
Today, Starwood is an attractive post-COVID reopening play with a 7%-plus dividend yield. Not too shabby.
Ellington Residential Mortgage REIT
- Market value: $148.6 million
- Dividend yield: 9.3%
For a smaller, up-and-coming mortgage REIT, consider the shares of Ellington Residential Mortgage REIT (EARN, $12.04). Ellington began trading in 2013 and has a market cap just shy of $150 million.
Ellington runs a portfolio consisting mostly of agency MBSes, but the company also invests in private, non-agency-backed mortgage securities and other mortgage assets. As of the company’s latest earnings report, the portfolio was weighted almost exclusively to agency securities. The REIT held $1.1 billion in agency residential MBSes and had just $17 million in non-agency. Ellington opportunistically snapped up non-agency MBSes when prices collapsed last year and has been slowly taking profits ever since.
Despite being a small operator, Ellington navigated the COVID crisis better than many of its larger and more-established peers. Its stock price lost 65% of its value during the March 2020 selloff, but by the beginning of the third quarter, Ellington had already recouped all of its gains.
Today, the shares yield a mouth-watering 9.2% and trade at a respectable 10% discount to book value. Considering that the industry itself trades very close to book value, that implies a healthy discount for EARN shares.
- Market value: $1.9 billion
- Dividend yield: 7.0%
Some mortgage REITs had it worse than others last year. A few really took damage as they were forced to sell assets into an illiquid market to meet margin calls. But some of these less fortunate mortgage REITs now represent high-risk but high-reward bargains.
As a case in point, consider MFA Financial (MFA, $4.26). MFA got utterly obliterated during the COVID crisis, dropping from over $8 per share pre pandemic to just 32 cents at the lows. Today, the shares trade north of $4.
MFA will never fully recoup its losses. By liquidating its assets at fire-sale prices during the margin calls, the REIT took permanent damage. But today’s buyers can’t worry about the past; we can only look to the future.
At current prices, MFA could be a steal. The shares trade for just 77% of book value. This means that management could liquidate the company and walk away with a 23% profit (assuming they took their time and weren’t forced to sell at unfavorable prices). They also yield an attractive 7%.
There is no guarantee that MFA returns to book value any time soon. But we’re being paid a very competitive yield while we wait for that valuation gap to close.