The math is pretty simple for investors looking to live off of the dividend income their portfolios generate: Bigger yields mean more income. But huge yields, like the 14.5% on offer from AGNC Investment (AGNC 0.97%), can't be taken on without a deeper look at the risks involved. Sometimes, a lower yield, like the 4.8% from Realty Income (O -0.17%), is the better choice.
Here's a comparison of these two real estate investment trusts (REITs) on three points to show why simple is better.
1. Property vs. mortgages
The single biggest difference between Realty Income and AGNC is that one owns properties and the other holds mortgage-backed securities, often in the form of debt known as collateralized mortgage obligations (CMOs).
Image source: Getty Images.
Realty Income's portfolio of more than 12,000 properties spans various property types (including vineyards) and countries (most of its foreign exposure is in Europe). And yet, it doesn't require much effort to understand what the company is doing. It tries to acquire physical properties that it believes it can rent out under long-term leases to tenants that will reliably pay their rent.
It is the same thing you would be doing if you bought a second home with the intent of renting it out. You could get into the nuances, like Realty Income's use of the net lease structure (this requires tenants to pay for most property-level expenses), but they are still just nuances.
The story is vastly different with mortgage REIT AGNC. This REIT owns a portfolio of CMOs and other securities that it buys using borrowed money, with the goal of maximizing the difference, or spread, between the interest rates it pays for debt and the interest it collects from the CMOs. CMOs trade openly, so their values can fluctuate quite quickly, with their prices impacted by changing interest rates, housing market dynamics, and simple investor sentiment.
A mortgage REIT is kind of like a bond fund focused on mortgages. Most investors understand how a mortgage works, but that really doesn't help one understand how CMOs and the CMO market works -- or, perhaps more importantly, how to manage a portfolio of CMOs in a fast-changing investment market.
If you like to keep things simple, Realty Income is the hands-down winner here.
2. The dividend
That said, you might very well be willing to learn new things to collect a huge 14.5% dividend yield. That, however, is only an attractive option if you can actually count on that dividend being sustained over time. In the case of AGNC, the dividend has headed steadily lower over the past decade or so. By contrast, Realty Income's dividend has headed steadily higher.
Data source: YCharts AGNC Dividend Per Share (Annual)
In fact, over the course of that decade, AGNC's dividend started at a higher absolute level but ended at less than half of what Realty Income investors are collecting today.
However, a decade isn't really enough time to appreciate Realty Income's dividend consistency. This REIT has increased its monthly pay dividend annually for 28 consecutive years. The average annualized increase over that span of 4.4% may not sound exciting, but that's kind of the point for this REIT, which has pretty much dedicated itself to slow, steady growth.
You might argue that you can get a bank CD with a 4.4% or better yield today. But you'll lose out on the dividend growth that adds up over time and helps you keep pace with, or outdistance, inflation. And clearly, a growing dividend beats the risk that you'll see a dividend cut, which clearly is a factor with AGNC.
3. Ups and downs
There's an interesting thing about dividend yields that's often overlooked: Like typical valuation tools (the price-to-earnings ratio, for example), a stock's dividend yield often trades within a range. You can see that with AGNC in a very dramatic fashion, as the chart shows. Although the dividend payout has headed steadily lower over the past decade, the yield has remained at a high level.
Yield and price move in opposite directions, which means that the high yield has been maintained only because the stock price has fallen. Not only have shareholders suffered a declining income stream, but capital losses as well.
The chart also shows that Realty Income's yield has long hovered in the mid-single digits. With the dividend growing over that time span, however, the only way to achieve that was with a rising stock price. The price increases weren't huge because the dividend increases weren't huge. But over time, investors have seen a growing income stream and an increase in the value of their investment. Clearly, that's a better outcome.
Keep it simple
Investing is hard, and the more difficult you make it, the more likely you are to make a mistake. AGNC is a highly complex investment that is only appropriate for highly engaged, active investors. Realty Income is a fairly easy-to-understand alternative with a history of steady performance.
Yes, its yield is lower than the yield you'd collect from AGNC. But usually, it's better to go with simple and steady over complex and risky, making Realty Income the better choice here.
