As far as mortgage real estate investment trusts (REITs) go, Annaly Capital (NLY 0.96%) isn't too unusual. But that doesn't make it -- or its double-digit dividend yield -- a good choice for investors. In fact, for most dividend investors, it will probably be a terrible investment option. Boring W.P. Carey (WPC 0.36%) is a better alternative.
The problems with Annaly
The very first thing that should worry investors about Annaly is that it is a mortgage REIT. This is a specialized type of entity that owns collections of mortgages that have been pooled into bond-like securities. The income Annaly generates comes from the cash these securities generate.
Here's the thing: These securities are publicly traded, and their prices go up and down over time. Interest rates and the state of the housing market can have an impact on how they trade. So, too, can simple investor sentiment. That means that the value of Annaly's business, which is basically the value of its portfolio, can rise and fall in sometimes dramatic fashion. In 2022, for example, the book value of the company fell from $31.88 at the start of the year to $20.79 by the end.
In and of itself, that's bad, but the risks get even higher because mortgage REITs tend to make use of leverage to increase returns. The hope is that the interest they earn from the securities is greater than the funding costs. That equation gets more complicated in a rising rate environment such as today's. Leverage can also magnify the pain when investments don't work out as planned. Annaly is a complex investment that comes with material risks.
The best example of the risks comes in the form of the dividend, which has been cut a number of times during the past decade. In fact, the REIT just cut the dividend again, taking it from $0.88 to $0.65 a quarter. The stock price has tracked the dividend lower over time, resulting in the yield staying in the double-digit range even today. This is a terrible option for dividend investors who are trying to live off of the income their portfolios generate.
Boring is better
W.P. Carey is much different. For starters, the stock's dividend yield is a comparatively modest 5.5%. However, the company has raised the dividend every year since the REIT's initial public offering in 1998. That is a lot more consistent than Annaly's history and shows a dedication to returning value to investors over time via a steadily increasing dividend payment. Most dividend investors will probably prefer to own a lower-yielding stock that they can actually count on.
W.P. Carey is also a traditional property-owning REIT. That means it owns assets it leases out to other companies that pay rent -- a fairly easy concept to understand. Further, it uses the net-lease approach, which means that its tenants are responsible for most of a property's operating costs. This simplifies the business model even more, which should make conservative investors happy.
On top of that, W.P. Carey is among the most diversified REITs you can own. It spreads its portfolio across industrial (27% of rents), warehouse (24%), office (17%), retail (17%), and self-storage (4%) property types, with a fairly large "other" category rounding things out. Geographically, it generates about 37% of its rents outside the U.S. You know how valuable diversification is for your portfolio, and it's a good thing for a REIT's portfolio, too.
In addition to these positives, W.P. Carey is one of the largest net-lease REITs, with a market cap of roughly $15 billion. Its portfolio includes more than 1,400 properties. And it has an investment-grade-rated balance sheet. This is a very strong and stable company that should be able to continue paying reliable dividends for years to come.
Not very exciting
Annaly Capital isn't a bad mortgage REIT per se, but it clearly isn't a great option for investors who need a reliable income stream. For that, you should focus on a company that's more, well, boring.
W.P. Carey is built to provide consistency throughout the market cycle. In fact, roughly 55% of its leases have rent escalators tied to inflation built into them, meaning that even a rising interest rate environment isn't going to be a big headwind for the business. Given how long interest rates were on the decline, the decision to include such escalators in leases shows considerable foresight.
That's something you'll find throughout W.P. Carey's business approach. And it's a key reason it is a better dividend stock than Annaly.
