High-yielding dividend stocks may look like an attractive buy at first glance, but high returns are usually high for a reason -- there's a risk.
Every stock has its own unique risk factors. Market volatility, short or long-term headwinds inhibiting the company's ability to grow, or poor management decisions like taking on too much debt are just a few reasons a stock's dividend yields are high and thus, carrying risk.
Rather than steering clear of high-yielding stocks altogether, investors should try to understand the cause of the problem to determine if the risks are worth the reward. For example, New Residential Investment Corp (RITM -0.16%) and Simon Property Group (SPG -2.57%) are real estate investment trusts (REITs) that are paying high dividend yields. Both REITs' high returns are being driven by very different risk factors. Here's what's happening with each.
New Residential Investment Corp
New Residential Investment Corp is a mortgage REIT, meaning it invests in mortgage-backed securities (MBS) as well as services and originates residential mortgages. Mortgage REITs as a whole are considered riskier investments because of the high amount of leverage and debt used to grow their portfolio.
Companies like New Residential create debt hoping to earn a return by collecting payments over the life of the loan. Today's rising interest rate environment is good for its servicing business and loan originations because of its ability to earn more over time by charging a higher interest rate. But higher interest rates also slow lending activity leading to less volume and impacting the cost of borrowing money for the company to grow, which can eat away at extra profits.
There's also the factor of recessionary risks. A growing number of analysts and experts are predicting a recession is coming, which could lead to an uptick in delinquencies. Mortgage delinquencies aren't good for companies like New Residential because they rely on monthly payments to pay things like debt obligations and dividends. Thankfully, New Residential's dividend payout ratio is at 41%, which means even if mortgage delinquencies rise, it's unlikely to cut its dividend in the near future.
In June, the REIT announced its plan to terminate its external management and become an internally managed company under the name of Rithm Capital Core. The move, which it's is expected to complete in Q3, will save Rithm millions of dollars annually but does leave an air of uncertainty. Investors will need to see the management team continue to maintain its growth without jeopardizing shareholders' value.
Its currently paying an over 10% dividend yield, which is lower than its historical average but the highest rate over the past year. It's also trading lower than its book value, meaning it could be a worthwhile buy for income investors who believe the company can fair well in the changing economic climate.
Simon Property Group
Simon Property Group is the largest mall operator in the world, with interests in and ownership of 234 premium outlet malls and indoor malls across the globe. Given the challenging landscape for brick-and-mortar retail over the last two years, it's understandable to hear that Simon is facing some challenges.
During the pandemic, dozens of retailers filed for bankruptcy or closed stores in an attempt to cut losses, including major malls anchors like J.C. Penney and Neiman Marcus. Malls' foot traffic pretty much disappeared for close to a year. As a result, Simon went into conservation mode, cutting its dividend payouts by 76%.
Thankfully things are looking up for the company, with each quarter showing improvements in leasing momentum and foot traffic for its tenants. Its fast-paced recovery has motivated the company to increase its payout four times over the last year.
The real risks and reasons behind its over 8% dividend yield are the unknown role malls will play in the future and the impact a recession could have on an already struggling industry. We're already seeing a trend toward less in-store shopping and more online shopping, and it's likely over the next few decades that trend should grow. This is a direct threat to the model of malls and is undoubtedly the reason its stock is trading at the bargain price of 8 times its FFO.
However, it doesn't seem to be a huge concern for Simon. The REIT resumed the development and expansion of 4 properties in the United States, all of which were put on pause during the pandemic. It recently repurchased $2 billion in shares, which can be seen as a vote of confidence in the company's future from its leaders. And it's introducing new concepts like Grab and Go Eat and innovative product search platforms to enhance mall users' experience.
These company's high dividend yields are largely thanks to the volatility in the marketplace combined with the higher risk both New Residential Investment and Simon Property Group carry. Given their low valuations and high yields, they still could be worthwhile buys for the right investor. Personally, I would wait to see if a recession becomes more evident before buying. If the recession impacts the companies in the way analysts believe, stock prices could go down further before recovering.