With interest rates close to 0%, finding yield can be a difficult endeavor. US Treasuries pay a whopping 0.94% in exchange for tying up your money for 10 years. One of the few sectors that consistently delivers yield is the real estate investment trust (REIT) sector.
REITs have many different business models. There are office REITs, apartment REITs, and data REITs. The two REIT sectors with the highest yields are generally retail REITs and mortgage REITs. Realty Income (NYSE:O) is one of the premier retail REITs, while AGNC Investment (NASDAQ:AGNC) is one of the top mortgage REITs. But which one is the better dividend stock?
Realty Income has increased its dividend despite COVID-19
Realty Income (aka the Monthly Dividend Company) is the classic real estate investment trust. The company owns properties and then leases them out to tenants under long-term leases where the tenant covers almost all of the expenses. The REIT sector refers to these types of retail REITs as "triple net" lease REITs. As a general rule, the triple-net lease REITs have long-term relationships with companies that are relatively insensitive to the economy. Realty Income's main tenants include convenience stores, drug stores, and dollar stores. The company's biggest tenants include Walgreen's, 7-11, Dollar General, and FedEx. Despite the COVID-19 slowdown, collections have been steadily improving, and the company reported that it collected 94% of rent in September. This business model has enabled Realty Income to continue to pay dividends during the crisis and even raise them in June.
AGNC's investments are guaranteed by the government
AGNC Investment is a mortgage REIT, which is a different animal compared to the traditional REITs. Mortgage REITs don't own properties, and they don't charge rent. Mortgage REITs are more similar to banks. They own real estate debt (such as mortgages). If you recently refinanced your home with your local bank, chances are your loan ended up in a mortgage-backed security on a mortgage REIT's balance sheet. AGNC invests almost exclusively in mortgage backed securities issued by Fannie Mae and Freddie Mac. These securities are guaranteed by the U.S. Government.
Credit risk versus interest rate risk
AGNC and Realty Income have different types of risk. Realty Income has a lot of credit risk, which is the risk that the tenants cannot pay their rent. If Realty Income's tenants cannot pay, the REIT still has to cover its interest payments. On the other hand, AGNC Investment's portfolio is comprised primarily of government-guaranteed mortgage-backed securities. This means that if the borrower cannot make its mortgage payments, the government will ensure that AGNC is still paid its principal and interest.
That said, a lack of credit risk doesn't mean that AGNC has no risk. Its business model entails interest rate risk and liquidity risk. These issues caused AGNC Investment to suffer big losses and to cut its dividend during the spring. When the economy is lousy, AGNC benefits since interest rates stay low. When the economy improves, interest rates will rise, which means a tougher environment for AGNC.
Realty Income pays a monthly dividend and has a yield of 4.7%. The company is part of the Dividend Aristocrats, which is an elite group of companies that have raised their dividends every year consecutively for at least 25 years. This is a record of stability that few other companies can claim. AGNC Investment is another monthly payer that has a dividend yield of 9.3%. The issues with COVID-19 and margin calls forced the company to cut its monthly dividend from $0.16 to $0.12. in April. AGNC did admit on its second-quarter earnings call that the cut was probably unnecessary in retrospect.
So which one is the better dividend stock? It depends on how much you value consistency. Realty Income has a stable business model that has survived over several business cycles. AGNC Investment has a higher yield, but the dividend has been more volatile. Much will depend on how COVID-19 plays out. Realty Income's tenants have managed to make their rent payments; however, the company does have exposure to the troubled gym and movie theater segments. If the economy recovers quickly, Realty Income will benefit more than AGNC, since credit risk will work in Realty Income's favor and interest rate risk will work against AGNC. On the other hand, if the economy goes into another extended slump, AGNC's government-guaranteed portfolio will probably outperform, especially since the Federal Reserve is actively supporting its assets.