The Number That Threatens These Huge Dividend Yields

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 (NYSE: NLY  ) , has only been operating since 1997. And even in that short time, its dividend payouts have been a rollercoaster. The highest-yielder of all, American Capital Agency (Nasdaq: AGNC  ) , has only been around since 2008.

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 (NYSE: CYS  )

$730

19.0%

Invesco Mortgage Capital (NYSE: IVR  )

$1,068

17.6%

Two Harbors Investment (AMEX: TWO  )

$396

16.4%

Chimera (NYSE: CIM  )

$4,234

16.2%

Annaly Capital

$12,464

14.5%

Resource Capital (NYSE: RSO  )

$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.  

Anand Chokkavelu does not own shares of any company mentioned. The Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (11) | Recommend This Article (47)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 26, 2011, at 5:05 PM, stmichaeldefends wrote:

    Let's stop bashing the REIT's It seems one Fool after another is constantly signaling disaster for those REIT's paying the high-flying dividends. Ok, Ok, sure interest rates are going to go up and some of these REITS are not going to borrow at the cheap interest rates to buy long-term seurities forever. But even if all this hand-wringing comes true, I'm still buying positions like Invesco. Why? What I'm doing is figuring a 50% cut in REITS if the interest rates go up. Using IVR as example I'll still be getting 8.8% dividend if it does fall form 17.6%. Try to match that among the Dividend Aristocrats. As good as Lily is it's only paying a yield of 5.6% at $35. And everytime I buy one of these ETF's with a decent yield in an effort to spread my risk over many stocks, they cut their divided. ETW just cut their dividend 22%! Corporate bonds even if you go for BBB you're lucky if you can get 2% for a short-term one. Money market? Forget it. I've got one small acount where they spend .44 cents to tell me i have .37 cents With proper discounting of the high-paying REITs, I'm not going to miss the money if I don't figure on it by cutting my expectations in half. And it they don't cut the dividend as soon as the nay-sayers are predicting, for me, it's so much gravy until they do cut. I think the REITS are the best deal around in my view.

  • Report this Comment On January 26, 2011, at 7:45 PM, neamakri wrote:

    I own CIM and MFA because they pay so well. And I understand that will change with interest rates.

    HOWEVER, fools should use due diligence. For example NLY has paid lower dividends the last 4 quarters in a row, and analysts predict AGNC will see a 20% drop in earnings next year. Fools do your homework before laying out money $$.

  • Report this Comment On January 26, 2011, at 8:09 PM, WilliamaA wrote:

    This is a very useful piece of analysis, thanks. I'm long NLY and have the same attitude as St. Michaels (though he could have made his point less stridently!) i.e. that even if the divvie is cut in half you're still getting a good yield.

    For the next bit of analysis, it would be v. interesting to take a look at maturity or duration gap of these companies, (though this is not easy to do).

  • Report this Comment On January 26, 2011, at 9:27 PM, worthless111 wrote:

    StMichael, excellent! This is how I plan only using AGNC . I think of it like my divorce..plan to lose half of everything and still thrive. Thanks for your analysis.

  • Report this Comment On January 27, 2011, at 12:32 AM, mongo1936 wrote:

    My comment is directed toward Fools management and the website, especially this Comments column.

    We, hopefully successful investors wish to read sincere comments about the various investment choices. We certainly do not wish to read through constant spam in the process.

    I have read the rules for posting and do not see any suggestion that spamming is OK.

    Yet in the comments above - and most probably in comments on other topics (I am not going to bother to verify) there are dozens of links to spam.

    I am very offended by the practice and sincerely hope that Fools.com can do something to eliminate it.

  • Report this Comment On January 27, 2011, at 12:46 PM, TMFBomb wrote:

    @mongo1936,

    We are working on lowering the amount of spam comments.

    You can report any rule-breaking comments by clicking on the little hand icon above each comment.

    Fool on,

    Anand

  • Report this Comment On January 27, 2011, at 7:00 PM, techy46 wrote:

    If interest rates rise and REIT earnings suffer it will be their share price that falls the most. IF CIM stumbles on earnings and it's share price crashes to $3, reduced earnings of $.08/quarter won't make a difference as the downward share price slide would nullify all earnings and more.

  • Report this Comment On January 30, 2011, at 3:15 PM, EllenBrandtPhD wrote:

    Your chart shows how UNDERvalued CIM is related to its peers!

    Which is why it's the one so attractive to sophisticated Big Institutions, which are its strongest supporters.

    CIM has been getting Analyst Target upgrades over the past few months. Two are now above 4.50, 1 above 4.60, and now two above 5.00. That's going to continue over the course of 2011, and personally, I expect CIM will hit 7.00 or more in first or second quarter 2012.

  • Report this Comment On January 30, 2011, at 5:47 PM, racchole wrote:

    I don't understand how anyone can use the logic that if a dividend gets cut in half, the yield is still acceptable. What about the standard rate of return on the stock price? I am making an assumption that if a yield is cut from 17% to 8%, then the stock price will surely suffer. And if this is true, then it makes zero sense how anyone can believe that the lower dividend yield will offset capital losses. Am I missing something or is the argument in question really valid?

  • Report this Comment On February 02, 2011, at 11:24 AM, ikkyu2 wrote:

    What about rate risk?

  • Report this Comment On February 02, 2011, at 2:08 PM, goalie37 wrote:

    I think that showing the risks of the mortgage REITs is important, but I would also like to suggest some articles on the REITs that own physical land. TMF does a great job, but I think this one area of the market is under covered.

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