Large yields are enticing for dividend investors, so much so that they can cause people to make bad long-term decisions to collect large near-term dividend checks. That is why it is so illuminating to compare Realty Income (O 0.45%) and Annaly Capital (NLY 0.66%). In the end, the real estate investment trust (REIT) with the lower yield has been the bigger winner.
What the numbers look like today
Realty Income offers a dividend yield of roughly 4.5% today. That pales in comparison to Annaly Capital's 16%. If all you cared about was yield, you would pick Annaly in a heartbeat. But yield isn't the only thing investors should be considering.
For starters, the two REITs do very different things. Realty Income is a net-lease landlord, which means it owns physical properties and its tenants are responsible for most of the operating costs of the assets they occupy. Across a large portfolio it's a pretty low-risk investment approach, and Realty Income is huge, with over 11,700 properties. On top of that, roughly 80% of its buildings are in the retail space, where properties are pretty interchangeable and easy to buy and sell. All told, Realty Income is a fairly boring company.
Annaly, on the other hand, is a mortgage REIT. It buys pools of mortgages that trade like bonds, commonly called collateralized mortgage obligations, or CMOs. Mortgage REITs generally use leverage, often backed by their portfolios, to enhance returns. The goal is to earn more from the investments than the cost of the debt. There are a number of risks here, including exposure to interest rate fluctuations, property market volatility, and the chance that a margin call is triggered by a drop in the value of an mREIT's CMO portfolio. Annaly is fairly well respected, but it is not a simple business to understand, and a relatively high yield makes some sense given the increased risk.
The question for investors: Is the added risk worth it? For that, a quick look at Wall Street history is in order.
Up, up, up and down, down, down
The first interesting piece of historical information is that the dividend yield disparity between Realty Income and Annaly has been fairly consistent over the past decade. In fact, Realty Income's dividend yield is just 6% or so higher than it was 10 years ago, so it was still in the 4% space back then. Annaly's yield is 16% higher than it was (more on this in a second), but it was still drastically more than what investors would have collected from Realty Income. So the yield choice that investors need to consider today is very similar to the one that they would have faced 10 years ago.
NLY Dividend Yield data by YCharts
But yield is a function of the dividend payment and the stock price, and that's where things get a bit frightening, at least for Annaly. Realty Income's dividend has increased each year over the past decade. Given that the yield is roughly the same, that means that the stock price has risen along with the dividend. Annaly, on the other hand, has cut its dividend multiple times over the past 10 years. The stock price has fallen along with the dividend, maintaining the high yield.
Put simply, investors got hit by a decline in income and a decline in the value of their capital. By comparison, Realty Income investors had a rising income stream and an increase in net worth. Taking a look at total return, which assumes that all dividends are reinvested, Realty Income vastly outperformed Annaly. So that huge starting yield did very little to help investors -- and, in fact, may have resulted in short-term thinking that ended up hurting them instead.
NLY Total Return Price data by YCharts
There's no way to predict the future, but the story here doesn't appear likely to change anytime soon. Realty Income just announced another dividend increase, marking the 119th time it has hiked its payout since becoming a public company. Meanwhile, Annaly management warned investors that yet another dividend cut is likely in the cards when the company held its fourth-quarter 2022 earnings conference call. That helps explain why the yield is particularly high today.
Buy the tortoise
Obviously, investors need to consider stocks on a case-by-case basis. However, comparing Realty Income and Annaly Capital highlights an important fact -- sometimes it pays to stick to reliably boring companies. In this match-up, history suggests that Realty Income is the better option.
