Finding high-yield stocks is simple with the use of a stock screener, but the problem is that once you use that screener you may realize that many of the stocks it singles out are mortgage real estate investment trust, or mREITs.
Unlike many of today's blue chips stocks that do something investors can identify with, mREITs are managed portfolios of real estate debt -- not exactly something they sell at the corner store. But much like swimming in the ocean, diving into mREITs is less shocking if you dip a toe in first. Here are three things to look for when you're getting acquainted with high-yield stocks.
1. Similar to what you know
Commerical mREITs are a good place to start, especially companies like Starwood Property Trust (NYSE:STWD), which currently yields 8%. The company originates and owns commercial mortgage loans, making loans to businesses for commercial property. Which, as a specialty lender, means it's somewhat similar to a bank.
Unlike a bank, which faces intense regulation, Starwood Property can be more flexible with its capital, focusing on making shorter-term and often more complex loans that banks shy away from. This helps to give the company a niche in the credit markets.
Most important, if you are new to high-yield stocks, or even if you're not, you should be looking for experienced management that readily shares its knowledge with shareholders. Starwood Property's CEO, Barry Sternlicht -- who is also the founder of Starwood Hotels -- is extraordinarily long-winded, and during quarterly conference calls you will undoubtedly learn something new about commercial real estate and investing in it.
2. Educating shareholders
Along the same line, Two Harbors (NYSE:TWO) -- which currently yields 9.8% -- has a fantastic management team led by CEO Thomas Siering and CIO William Roth, who go above and beyond to educate shareholders by flooding their investor relations website with presentations and webinars about Two Harbors and the industry as a whole. These are extremely useful tools for anyone interested in mREITs.
Moreover, unlike many companies that use the "do now, ask permission later" approach, Two Harbors is open with shareholders. For instance, the company disclosed its intention to enter commercial real estate debt -- a new business line -- in a press release last November, which was followed by a presentation laying out the opportunity it sees, even though it is not planning to pull the trigger on these investment until later in 2015.
Ultimately, I think there is something to be said for companies that are more transparent than required, and actively reach out and teach investors about how their company works. This is especially important for companies like Two Harbors, which, as you see below, invests in a wide variety of assets.
Two Harbors' focuses on two major assets classes: residential loans and mortgage securities that are exposed to credit risk (light blue/credit) -- that is, risk the asset will default -- and fixed-income securities that are not exposed to credit risk (dark blue/rates).
Two Harbors does a good job balancing risk and opportunity, but what is important is that the company is upfront with shareholders and presents information in a way that is digestible for the average investor.
3. A long track record
I believe Two Harbors and Starwood Property have what it takes to break the mold, but they are young companies -- both went public following the financial crisis in 2008 -- that own assets with credit risk, and these types of mREITs have an unfortunate history of growing rapidly and then blowing up when recessions inevitably strike.
For this reason, starting with a company like Annaly Capital Managment (NYSE:NLY) with a longer track record that focuses on more durable assets can make sense.
Like Two Harbors, Annaly is a managed portfolio of residential mortgage debt, and sports a 11.3% yield. However, Annaly focuses almost exclusively on agency mortgage-backed securities, and these fixed-income investments are protected against default.
mREITs use their assets as collateral to borrow short-term and in high amounts -- total liabilities can be well over five times total equity -- and their turbulent history is because during recessions you are hard-pressed to find banks willing to lend against iffy assets. This can leave companies with sudden, and sizable, cash obligations.
Annaly's focus on high-quality assets insulates it from this risk and has been key to its ability to withstand economic swings, and has allowed the company to operate successfully since it went public in 1997.