It's hard to deny the allure of mREITs like American Capital Agency (NASDAQ:AGNC) and Annaly Capital (NYSE:NLY). They offer quarterly dividends in excess of virtually any other asset class. And, until the last 12 months, promised consistently with capital appreciation.
Then the taper happened -- well, fears of a taper. Since then, mREIT spreads have risen, but book values have plummeted. Conservative management style brought lower dividends.
American Capital Agency recently paid a $0.65 dividend, down from the $1.40 at the peak in 2012 and 2013. It now yields about 12% per year. Annaly Capital pays just $0.30 per quarter, for a 12% yield, down significantly from a recent peak dividend of $0.68 per share in 2010.
Safer mREIT yields
All mREIT investors should carefully consider preferred stock as an alternative to mREIT common shares. Unlike the common stock, preferred shares have minimal risk to a future dividend cut.
Let's look at American Capital Agency's preferred first. The preferred shares pay $0.50 quarterly, equal to 7.8% at the current price. Investors will receive dividends forever -- for as long as American Capital Agency exists, or until the preferred stock is called at $25 per share. Investors can be certain of the dividend until the call date of April 5, 2017. If rates rise, it's highly unlikely preferred shares will be called when 2017 rolls around.
Annaly Capital also offers high-yielding preferred shares. Annaly Capital's Series D Preferred stock pays $1.875 in dividends per year, with payments coming each quarter. At the current price, investors will enjoy a yield of 8.16% per year, as the preferred shares trade at a discount to par. Like American Capital Agency's preferred shares, these cannot be called until September 2017.
Preferred stock vs. common
The trade-off between preferred or common mREIT shares comes down to giving up 12% yields for 8% yields, but at the benefit of more certain dividends and a lower risk of capital loss. Sure, mREIT common stock and all preferred stock generally drop in value as interest rates rise. However, mREIT's common stock leverage results in much more interest rate volatility than the preferred shares.
Additionally, preferred shareholders have better protection as they have priority over common shareholders. The common stock dividend would have to fall to zero before preferred shareholders are at risk of losing their payments.
The bottom line is this: mREIT investors who are concerned about volatility or dividend cuts might be better suited for the preferred stock. At 8% per year, preferred shares offer a very compelling alternative to the common.
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Jordan Wathen has no position in any stocks mentioned, and neither does The Motley Fool. 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.