The current financial environment is difficult for income investors. With interest rates stuck at extremely low levels, the risk/reward proposition in government and corporate bonds is stretched. Investors looking for income might have to go to the stock market. Fortunately, there are a few with decent yields that are in a good position -- and many owe their good prospects to conditions in the housing market.
Housing has returned to its usual position as an early-stage cyclical. As we are just exiting the pandemic-driven recession, these stocks should benefit from the drop in interest rates and the rise in commodity prices. It may seem counterintuitive to search for income in stocks that benefit from low rates, but these stocks provide better yields than most bonds.
Skyrocketing lumber prices will help Weyerhaeuser
If you've been pricing materials for a home improvement project, you may have noticed that lumber is a lot more expensive than it used to be. While some of the cost increase is due to temporary shortages caused by COVID-19 disruptions, it's also being driven by a housing shortage and homebuilder demand. In other words, the demand for lumber is not temporary. And higher lumber prices directly benefit Weyerhaeuser (WY 2.60%), one of the largest owner-operators of timberland in North America.
Homebuilding activity is finally picking up, with March housing starts rising 30% year over year to 1.8 million units. The work-from-home trend has made the exurbs more attractive, and cheaper land will help ease some of the affordability issues. This is great for Weyerhaeuser because residential construction accounts for most of its earnings.
Weyerhaeuser pays a normal quarterly dividend of $0.17 (which yields 1.8% at Thursday morning's prices) and also will pay a supplemental dividend based on earnings in the first quarter of 2022. Weyerhaeuser intends to pay shareholders between 75% and 80% of funds available for distribution via the quarterly dividend, the annual variable dividend, and share buybacks. With lumber prices having tripled over the past year, Weyerhaeuser shareholders could be rewarded richly early next year.
Less mortgage refinance activity means good news for Annaly
While mortgage real estate investment trusts (REIT) had a difficult 2020, the outlook for the space is improving, as the government imposed new limits on the types of mortgages federal agencies can guarantee. Annaly Capital Management (NLY 2.88%) is a mortgage REIT that concentrates primarily on these loans.
While Annaly doesn't take any credit risk (because the loans are backed by the government), it does have the risk that these loans will pay off early. By narrowing the Fannie Mae and Freddie Mac "credit box," refinancings for these loans will fall, which means fewer prepayments.
Annaly recently sold off its commercial real estate assets and will be redeploying that capital back into mortgages. The new loans that fall outside the Fannie and Freddie credit box will have higher yields, which will also help grow revenue. Annaly pays a quarterly dividend of $0.22 per share, which works out to be a 10% yield at Thursday's prices.
Limits on Fannie and Freddie risk benefits New Residential
The narrowing of Fannie Mae and Freddie Mac's credit box also benefits another REIT: New Residential Investment (NRZ 2.47%). Unlike most mortgage REITs, New Residential also has an operating company that originates mortgages. The change in policy will drive demand for New Residential's non-qualified mortgage (non-QM) business. New Residential will earn fees by originating the mortgage, which it will then hold on its balance sheet or securitize.
New Residential trades at a discount to book value, and the market has been assigning very little value to the origination arm. At current levels, New Residential pays a quarterly dividend of $0.20 which works out to be a dividend yield of 7.7%.