What happened

Shares of mortgage real estate investment trust (mREIT) Redwood Trust (NYSE:RWT) rose 17% on Friday, as the broader market rallied strongly in early trading. The upturn in the market was largely a bounce back from a huge daily loss the day before, with many stocks that joined in the rally giving up a material portion of their gains before the day was over.

Although there was a last-hour bounce, the S&P 500 Index also lost momentum as the day wore on and wound up giving back a portion of its early advance. Redwood Trust, on the other hand, ended the trading day near its highs. There was clearly more going on here...

So what

The good news that buoyed Redwood Trust's shares was a dividend cut: a pretty material one at that, with the quarterly payment dropping 60%. The REIT's yield before the cut was nearly 18%, so investors had pretty much been expecting the news. That large a cut, however, would usually be associated with a stock decline, not a strong advance.  

The acronym REIT spelled out on dice sitting atop coins

Image source: Getty Images

Only these aren't normal times, with COVID-19 pushing the United States into a swift and deep economic downturn. That has included dislocations in key financial markets that mREITs like Redwood Trust rely on to raise debt and support their use of it. So a 60% cut is actually not a terrible number, all things considered.

Adding to the positive here is the fact that the housing market has shown some notable resilience in the face of the coronavirus. In other words, this could be as bad as it gets for Redwood Trust's dividend. 

Only time will tell if that's true, since there's still a lot of uncertainty surrounding COVID-19 and the long-term impact it will have. But at least for now, dividend investors are taking some solace in this bit of good/bad news out of Redwood Trust. Brokerage firm Raymond James also appears to think the outlook has improved here, as it raised its target price for the REIT by nearly 15% to $8 a share.  

Now what

Redwood Trust's dividend cut is actually an important thing for long-term dividend investors to contemplate. It isn't the first time the REIT has ended up trimming the payout, with the last cut coming in 2010, after the deep 2007 to 2009 recession had run its course. Put simply, the mREIT business model makes heavy use of leverage, and that has a bad habit of leading to dividend cuts when times get tough.

Although investors appear to be cheering the news that the outcome this time around wasn't worse, in the end, Redwood Trust probably isn't the best REIT for income investors looking to find stable dividends that they can rely on through good times and bad.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.