The big number at real estate investment trust (REIT) Annaly Capital Management (NLY 1.02%) is its dividend yield, which at 13% is many times more than the 1.5% you would get from an S&P 500 index fund. It is also materially higher than the 4.4% you can get from the average REIT, using Vanguard Real Estate ETF as a proxy. These yield differences should get you wondering about what's going on with Annaly.
Not your average REIT
When most investors picture a real estate investment trust they probably think of a company that owns physical properties, leasing them to tenants to generate rental income. That's not particularly complex and is exactly what you would do if you owned a rental property. The only real difference is that REITs own large portfolios of institutional and commercial properties. Buying a REIT allows you to participate in a property arena that would probably be out of reach to you. Property-owning REITs are fairly attractive and, when operated conservatively, very reliable income stocks.
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Annaly is not this kind of REIT. Annaly is what is known as a mortgage REIT. As that suggests, Annaly invests in mortgages. In this case, it generally owns mortgages that have been pooled together to trade like a bond, often called something like a collateralized mortgage obligation (CMO). Mortgage REITs generally use leverage in an effort to enhance returns, hoping to earn more from the interest payments they collect than what they pay in interest on the loans they take out to buy the mortgage securities.
There are a lot of factors that affect a mortgage REIT's performance. For example, CMOs trade regularly and their values can fluctuate wildly at times. Interest rates, the housing market, and mortgage payment trends, among other things, can have a notable impact on the financial results of a mortgage REIT. And that, in turn, can materially impact a mortgage REIT's ability to pay dividends.
Annaly's dividend has gone down, down, and down some more
This is where the rubber hits the road for Annaly. During the past decade the mortgage REIT's dividend has headed steadily lower, falling by roughly 40% over that span. If you were looking for a reliable dividend stock, history suggests that you will be disappointed here.
But there's another wrinkle. The dividend yield has remained lofty, usually higher than 10%, over the past decade. How is that possible if the dividend has fallen by 40%? The answer is that the stock has declined by an even larger 50%! That's just basic math, since yield is simply the annual dividend divided by the stock price. If the dividend goes down the only way to keep the yield high is for the stock price to fall.
Data source: YCharts
If you are an income investor trying to live off of the dividends your portfolio generates, owning Annaly over the past decade would have been a disaster for your portfolio. You would have ended up with less dividend income and a huge capital loss. Essentially, the worst possible outcome. Notably, Annaly paid a dividend of $0.65 per share in the third quarter of 2023 while generating earnings available for distribution of $0.66. That doesn't leave much of a cushion for the dividend, which is probably why the yield is so high right now -- investors are worried that another dividend cut could be around the corner.
A unique REIT that most should avoid
The truth is that Annaly isn't really meant for average investors. It is most appropriate for large institutional investors, like pension funds, that look at total return (which assumes dividend reinvestment) and that emphasize portfolio diversification. At the end of the day, most average investors will be better off sticking to conservatively run property-owning REITs. Annaly's dividend history proves that the payout isn't reliable enough to include in an income-generating retirement portfolio.
