A lot of income investors own shares of the iShares Mortgage Real Estate Capped ETF (NYSE: REM) as a stock market investment that pays a high (almost 9%) current dividend yield. The problem with REM is that it holds a lot of the highly leveraged – dangerous to your wealth – residential mortgage-backed securities, or as they are regularly referred to (MBS REITs).
For most of the last year, the REM share price has been steadily marching higher. Over the last month the uptrend reversed with the share price declining by about 5%. That drop indicates that for many companies in the fund’s portfolio, higher interest rates and a flat yield curve are a danger to profits and continued dividend payments. A better option for the high-income focused investor is to build a portfolio from the financially strongest stocks out of the REM holdings list.
According to the tax rules that govern its operation, a REIT can own real estate property or participate in the financing of real estate assets. REITs that focus on owning real estate are referred to as equity REITs, while those that focus on the mortgage side of real estate are called finance REITs. The finance REIT side of the REIT universe typically carries much higher dividend yields, which are very attractive to income-focused investors. For comparison, REM currently yields 8.8%, and the largest equity REIT ETF, the Vanguard REIT Index Fund (NYSE: VNQ), yields 4.6%.
A significant number of finance REITs employ a business model that involves owning government agency guaranteed MBS and leveraging their MBS portfolios to turn the 3% bond yields paid by these safe MBS into the cash flow to pay a double-digit dividend yield. Changing interest rates at either the short or long end of the yield curve will eat into one of these company’s cash flow generation ability.
If you look at their histories, most are now paying dividends that are much lower than just a few years ago. For example, just over a year ago one of the larger and more popular agency MBS REITs, American Capital Agency Corp. (NASDAQ: AGNC) reduced its dividend by 10%. The new rate is just 43% the size of the dividend AGNC investors were earning in 2012. With the Treasury yield curve continuing to flatten, I would not be surprised by another dividend cut in the near future. As a fund that owns a portfolio of 40 different finance REITs, the REM dividend has shrunk from $6.89 annualized over the last five years to $3.93 paid over the most recent four quarter. The result is a share price that has also dropped, leaving an average annual return of 7.1%, even though the dividend yield was well above 10% for most of the period. Factor in taxes and the iShares website reports an annual return for REM of 2.78%.
To build a min-REM portfolio that gives a higher yield and does not destroy principal value, the strategy is to buy those finance REITs that have not been slashing dividend rates because their business models failed to adjust for changing interest rates. Here are five stocks out of the REM holdings that have not reduced dividends in the last five years:
Starwood Property Trust, Inc. (NYSE: STWD) is a commercial mortgage lender. Its five-year average annual return is 12.2% and STWD currently yields 8.9%. The company’s primary business is the origination of commercial property mortgage loans. The loans are then held in Starwood’s portfolio. The company also operates a commercial mortgage servicing arm and owns a small portfolio of commercial real estate properties.
Chimera Investment Corporation (NYSE: CIM) primarily owns non-investment grade MBS and has not reduced its dividend since early 2012. The stock has produced an average annual return of 23.7% over the last five years. Chimera recently reported third quarter earnings $139.2 million. Its next dividend payment is January 30, 2018 for stockholders of record on December 29, 2017. CIM currently yields 11.1%.
MFA Financial, Inc. (NYSE: MFA) owns a diversified portfolio of mortgage securities. The MFA dividend has been stable over the last six years and has not changed for the last four years. The stock has returned an average 14.0% annually to investors over the last five years. MFA’s most recent dividend payout was on October 31st for stockholders of record on September 28th. Look for their next dividend on the last business day of January 2018. MFA yields 10.1%.
Apollo Commercial Real Est. Finance Inc. (NYSE: ARI) makes commercial mortgage loans and invests in other commercial property debt securities. The company has been increasing its dividend over the last few years and investors have earned an average 14.0% per year over the last five. ARI currently yields 10.0%. The stock is up just over 5% for the year and over the past five years has traded in a range between $12.00 and over $19.00. Based on historical payment patterns Apollo’s next dividend payment should be in mid-January 2018.
Arbor Realty Trust Inc. (NYSE: ABR) invests in a diversified portfolio of structured finance assets in the multifamily and commercial real estate markets. This stock has returned an average 18.3% per year to investors over the last five years. Arbor goes ex-dividend tomorrow, November 14th and pays on November 30th. ABR currently yields 9.1%.
Out of the 40 stocks owned by the REM ETF, that is what I found. Five that have produced solid five-year returns and no significant reduction in their dividends. With this group, you would have earned more than double the REM total return. More importantly, these give a much higher level of safety to dividend payments going forward.
These are the same kinds of stocks that I recommend as a core part of my high-yield income system called the Monthly Dividend Paycheck Calendar. It’s a system used by thousands of dividend focused investors right now to produce average monthly paydays of nearly $4,000 in extra income. And it’s helped to solve a lot of income problems and retirement worries. I know because my readers write in telling me so.
Quality REITs need to be a core component to your income portfolio. Not only do you get the high yields but you also enjoy rising dividends and as we’ve seen from historical examples, share price gains as an added bonus. There are several best in class REITs in the portfolio of my Dividend Hunter service which features the Monthly Dividend Paycheck Calendar.