The Market's Hottest Dividend Sector

"What the wise man does in the beginning, the fool does in the end."
--Warren Buffett

With eye-bulgingly huge yields, the mortgage REIT sector has become a true market darling. Yields such as Annaly Capital's (NYSE: NLY  ) 14.4% or American Capital Agency's (Nasdaq: AGNC  ) 20.1% have become too tempting for yield-starved investors in a near-zero interest rate world. And financial backers sponsoring IPOs have been rushing to market to take advantage of the opportunity.

According to The Wall Street Journal, seven of the nine real estate investment trusts that have filed for IPOs so far this year will invest in mortgage-backed securities. Those nine deals are looking to raise $2.6 billion in capital, the largest amount for mortgage REITs since 2009. Among the largest REIT IPOs are Pimco REIT, which is looking for $600 million, and American Capital Mortgage Investment, which seeks $500 million. These mortgage REITs cater specifically to retail investors.

And it's not just these new players who are out raising capital. The usual suspects have also been out hawking shares for fresh cash. Mortgage REITs invested in agency mortgage securities have scratched together some $6.6 billion in new cash since December. That includes players such as Annaly, which raised more than $1 billion. Recently, American Capital Agency and Invesco Mortgage Capital (NYSE: IVR  ) also announced secondary offerings, pulling in more than a billion dollars combined. And American Capital Agency, Hatteras Financial (NYSE: HTS  ) , and Chimera (NYSE: CIM  ) have issued billions in new shares over the last few years.

A quick sample of the industry shows the high-yield allure:

Company

Leverage

Yield

Annaly Capital 678% 14.4%
Chimera Investment 110% 14.4%
Hatteras Financial 765% 14.7%
Two Harbors Investment (NYSE: TWO  ) 306% 16.0%
Cypress Sharpridge (NYSE: CYS  ) 500% 20.1%
American Capital Agency 768% 20.1%
Invesco Mortgage Capital 417% 19.3%

Source: Capital IQ, a division of Standard & Poor's.

Mortgage REITs make their money by borrowing at short-term rates and buying long-dated mortgages, and pocketing the spread between the two. They then lever up their balance sheet in order to exploit that spread, as you can see in the table above. Those yields trounce most of what you can find in traditional REITs.

And yet, given the move into the space by new players and the capital raises by established companies, you have to wonder how long the party can continue. Eventually, this rivalry will force some desperate players to buy lower-quality investments. Still, the basic ingredients for these high-yielders do remain favorable for now: low short-term rates and even somewhat rising longer-term rates, as my colleague Dan Caplinger notes. And as long as those conditions sustain, it looks like the good times can still roll, and that's why I have Annaly in my own portfolio.

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Jim Royal, Ph.D., owns shares of Annaly. The Fool owns shares of Annaly Capital. 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 (3) | Recommend This Article (18)

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 April 13, 2011, at 4:55 PM, Fudex wrote:

    At the moment American Capital Agency looks very cheap at $28. I doubt the price will go much lower. I went all in at 28.10.

  • Report this Comment On April 14, 2011, at 4:37 PM, busterbuddy wrote:

    I just don't believe the companies listed above are sound long term investments. I owe one of them but I'm watching it alot. Historically these type of yield are abnormal and just don't sustain. One reason is if they did the market would soon force the price up to the yield would be normalized. Second reason is the questionability of revenue generation at these rates. If these rates were maintainable everyone would run to the business and thus again normalize the yield. These two events are not occurring Lastly I've alway looked at historical data that says twice the 10 or 30 year rate on dividends was great. Thus between 6.2 and 8 are my limits. And 4.0 to 4.5 on high revenue stocks. My view is if you run out and purchase these stocks listed in this list you should limit your exposure because your going to lose principle and the compounding is just not going to occur. And compounding over years is the best investment period. Stocks that don't pay dividends don't compound anything but the market makers pocket.

  • Report this Comment On April 17, 2011, at 3:02 PM, thopau wrote:

    I too have followed many of these stocks and as of 10/15/2010: NLY was $17.99, CIM $4.14, AGNC $27.61. Not much growth since then but true a good dividend. Other stock are out there that pay both a excellent dividend, and have had super growth BTE is my favorite. I believe you can pick stocks that will give you a better overall return even better than the 14% + tauted.

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