High dividend yields aren't always a great thing for investors. In fact, a high yield is often a sign that the market thinks the dividend is at risk and likely coming down, especially if it's out of line with the company's peers.
But sometimes whole sectors have high yields because they're out of favor with the market, and in those instances the top performers might be worth an investment. Today, I'm going to tell you about two such companies. Real estate investment trusts (REITs) have been hurt by the COVID-19 crisis, and some REITs, like those specializing in mortgages and malls, have been battered. But these two REITs are survivors -- and I believe they have a lot to offer income investors.
Image source: Getty Images.
Mortgage REITs are different
AGNC Investment (AGNC -1.44%) is a mortgage real estate investment trust (mREIT), which is a bit different from the typical REIT. Most REITs own property and lease it out. For example, Realty Income owns single-tenant buildings and rents them out to drugstores, supermarkets, and gas stations. It is an easy business model to understand. But mREITs don't own buildings, they own securities. They earn the difference between what these securities pay and their cost of borrowing. The inherent risks of this model mean mREITs typically have high yields even in the best of times.
The mREIT sector was hammered during the COVID-19 crisis as the value of their assets fell and their creditors required additional capital. Every company in the sector was affected, although AGNC weathered the crisis the best. It invests almost exclusively in agency securities -- that is, mortgage-backed securities backed by U.S. government agencies. These tend to be less risky than non-agency securities because the principal and interest are guaranteed, and there is very little chance of default.
AGNC Investment pays a monthly dividend of $0.12 per share and yields a little over 10% based on Tuesday's prices. The company also recently announced that as of July 30, tangible book value per share was $14.84. So in addition to that yield, investors are currently getting a roughly 5% discount to book value. Again, mortgage REITs have always earned higher-than-normal dividend yields, so a double-digit yield is not necessarily an indication that something is wrong. If you're ready for mREIT investing, AGNC is a good option.
Escape from New York? Not so fast
Another interesting REIT with a high dividend yield is SL Green Realty (SLG -2.84%), an office REIT specializing in Manhattan real estate.
The pandemic has demonstrated the feasibility of working from home for millions of people, and that has caused many investors to question whether this will trigger a mass migration out of cities. But on its latest earnings call, SL Green poured cold water on the theory that New York commercial real estate is dead. For starters, the company has collected 96% of contractual rent through July. Second, the company signed 280,000 square feet of office space during the second quarter and sold two buildings. In conversations with its current tenants, SL Green noted that most of them intend to get to 50% staffing right after Labor Day. SL Green itself is at close to 100% staffing.
And don't forget: While it is easy to get from the suburbs to Manhattan on public transportation, it is not easy to get from suburb to suburb. So, while it is conceivable that companies may choose to move to Westchester County, just north of New York City, or Fairfield County in Connecticut to save on rent, their employees living on Long Island or in New Jersey will not be happy.
SL Green pays a monthly dividend of $0.295 per share, which works out to $3.54 annually, or a 7% dividend yield at Tuesday's prices. Last year, the company generated $7 per share in funds from operations. This is a better measure of a REIT's operating performance than net income, because real estate has a lot of depreciation and amortization -- a non-cash charge that depresses earnings per share and understates a company's cash flow. Given these numbers, SL Green has a payout ratio of 51%, which is relatively conservative.
While the COVID-19 crisis has certainly put a strain on commercial real estate, it is premature to make the call that work-from-home is a new model that every business will adopt. In the meantime, SL Green's dividend yield is much higher than that of other office REITs like Boston Properties or Kilroy Realty, simply because of the escape-from-New-York concerns of investors.
