If you've perused a list of the top dividend yielders in the market, you know that the list is utterly dominated by real estate investment trusts (REITs).
My fellow Fool Eric Bleeker recently gave a general history lesson on why the biggest yielders don't necessarily stay that way.
There are specific risks, too. Many of today's high-yielding REITs make their money borrowing cheaply (the Fed is keeping those interest rates historically low) and buying longer-term mortgage-based securities. These are ideal conditions and even the most illustrious member of this group, Annaly Capital
There are certainly risks in REITs, but if you're interested in them, I want to show you an initial step in evaluating them. Taking this step may highlight a key weakness in your favorite REIT. Before that step, take a look at the highest yielders; there are 13 REITs with market caps above $200 million that currently yield at least 10%.
Company |
Market Capitalization (in millions) |
Dividend Yield |
---|---|---|
American Capital Agency |
$2,511 |
19.7% |
Cypress Sharpridge Investments |
$730 |
19.0% |
Invesco Mortgage Capital |
$1,068 |
17.6% |
Two Harbors Investment |
$396 |
16.4% |
Chimera |
$4,234 |
16.2% |
Annaly Capital |
$12,464 |
14.5% |
Resource Capital |
$392 |
14.4% |
Hatteras Financial |
$1,590 |
14.1% |
Anworth Mortgage Asset |
$829 |
12.8% |
Capstead Mortgage |
$885 |
12.4% |
MFA Financial |
$2,267 |
11.6% |
Walter Investment Management |
$467 |
11.0% |
Dynex Capital |
$311 |
10.2% |
Source: Capital IQ, a division of Standard & Poor's.
Now on to that step. Let's see how much leverage each of these REITs is employing. By leverage, I mean debt (as opposed to equity). In good times, leverage does wonders for a company's ability to generate profits (and keep up big dividend payments). Recall that the massive leverage Wall Street banks were using before the financial crisis was a key factor in their downfalls.
Below, I'm adding a new column to the table I showed you earlier. This time, I include an indication of leverage, using the assets-to-equity ratio.
Company |
Market Capitalization (in millions) |
Dividend Yield |
Assets-to-Equity Ratio |
---|---|---|---|
American Capital Agency |
$2,511 |
19.7% |
11.4 |
Cypress Sharpridge Investments |
$730 |
19.0% |
8.5 |
Invesco Mortgage Capital |
$1,068 |
17.6% |
4.9 |
Two Harbors Investment |
$396 |
16.4% |
5.0 |
Chimera |
$4,234 |
16.2% |
2.5 |
Annaly Capital |
$12,464 |
14.5% |
8.6 |
Resource Capital |
$392 |
14.4% |
5.9 |
Hatteras Financial |
$1,590 |
14.1% |
6.9 |
Anworth Mortgage Asset |
$829 |
12.8% |
7.5 |
Capstead Mortgage |
$885 |
12.4% |
8.2 |
MFA Financial |
$2,267 |
11.6% |
3.7 |
Walter Investment Management |
$467 |
11.0% |
3.1 |
Dynex Capital |
$311 |
10.2% |
4.8 |
Source: Capital IQ, a division of Standard & Poor's.
Using American Capital Agency as an example, it is supporting $11.40 of assets for every dollar of equity it has. Put another way, it has $10.40 of debt and other liabilities for every dollar of equity.
You'll notice that American Capital Agency leads the list not only in dividend yield, but also in leverage, creating a possible "the bigger they are, the harder they fall" scenario. Contrast that with Chimera, whose dividend yield is only a few percentage points behind but has an assets-to-equity ratio of just 2.5.
That's a pretty huge disparity. Chimera is being much more conservative when it comes to leverage.
Don't get too excited, though. This is just a first step in analyzing this list of high-yielding REITs. For example, consider that American Capital Agency invests in agency securities (hence the name) -- in other words, it invests in mortgage-backed securities that are guaranteed by an entity like Fannie Mae. With government backing, the risk of default is pretty much nil.
Chimera, meanwhile, primarily invests in mortgage-backed securities that aren't agency securities. So, it's employing less leverage but is investing in securities with greater default risk.
The takeaway
If you decide you're interested in high-yielding REITs (and that should be a carefully thought-out "if") this list can be a good place to start. We've isolated the REITs throwing off more than 10% yields and taken a look at the leverage they're employing.
That's a good first step, but there are many nuances within the business models and the balance sheets of these REITs, so do your research and tread carefully.
If you're looking for a good breakdown, we recently wrote a report highlighting five stocks that Motley Fool has bought for its own account. One of the five stocks is also on the list of high-yielding REITs above. If you'd like to see the entire buy thesis on that stock (as well as the analysis on the other four), I invite you to download it for free. Just click here.