If you are a retired investor trying to maximize the income your portfolio generates, chancing upon a real estate investment trust (REIT) with a roughly 13% dividend yield might seem like finding a diamond in the rough. That's just not the case when it comes to Annaly Capital Management (NLY 1.02%). Here's why this stock is not the bargain you may think it is.
Mortgage REITs are a different beast
The big story with Annaly is that it is a mortgage REIT (m-REIT). While a property-owning REIT can be a fairly reliable and boring business, m-REITs are often the polar opposite. Mortgage REITs kind of go against the logic of why REITs were created in the first place -- to provide individual investors access to institutional-level properties. The idea is simple enough; a REIT buys physical property and leases it out, just like you might do with a second house. It's not a complex business model and, done well, not a risky one, either.
Image source: Getty Images.
Mortgage REITs don't own physical assets. They own what amount to IOUs on property. Normally, the assets they buy are pools of mortgages that trade like bonds, often called something like a collateralized mortgage obligation (CMO). Leverage is a normal part of the model, too, often backed by the value of an m-REIT's portfolio. That can lead to a downward spiral when CMO prices fall since a swift move could lead to a margin call.
What's most troubling is that the value of a mortgage is impacted fairly quickly by a large number of factors. For example, the housing market, the lending market, interest rates, and market sentiment, to name just a few things. Given that CMOs trade regularly, it can be very hard to get a handle on what to expect from a mortgage REIT like Annaly. Physical properties are usually bought and held for extended periods of time.
If you are looking for a reliable income stock, Annaly just isn't the right call, even though it has a very impressive 13% dividend yield.
Investors have lost two times over
The proof of that last statement is found in Annaly's dividend history. As the chart below shows, the REIT's dividend has been in a steady downward trend for the last decade. In fact, the most recent cut to the dividend came in the first quarter, when it was reduced by a painful 26%.
NLY Dividend Per Share (Quarterly) data by YCharts.
So investors that bought this stock hoping to collect a fat dividend check each quarter have actually seen their dividend income decline over time. But here's the interesting thing: As this second chart shows, Annaly's dividend yield has long been in the double digits. So, despite a history of dividend cuts, Annaly is likely to have popped up on high-yield dividend screens even while it has been regularly letting income investors down.
NLY Dividend Yield data by YCharts.
That makes sense, however, because dividend yield and stock price go in opposite directions. So every dividend cut has basically been followed by investor selling. There's nothing shocking about that; you might be tempted to do the same if you bought it and then got hit with a dividend cut. But this last chart puts it all together: Lower dividends lead to lower prices, which keeps the yield high.
For investors that thought they had found a high-yield bargain, however, the outcome was as bad as it could get. Not only did the income stream fall, but so did the stock price, leading to capital losses. That is a terrible result if you are retired and trying to live off of the income your portfolio generates.
Pass on this "bargain" dividend stock
It is entirely possible that Annaly will get its dividend back on track, but the history here suggests that there is just too much risk to get involved. You would be better off buying lower-yielding property-owning REITs that have proven they can increase their dividends in good markets and bad ones. A quick list to start with might include Federal Realty, Realty Income, and W.P. Carey. All have decades of dividend increases to brag about, the exact opposite of Annaly, which just has a string of dividend cuts.
