Three strikes and you're out.
Three major mortgage REITs -- American Capital Agency (NASDAQ:AGNC), Annaly Capital Management (NYSE:NLY), and American Capital Mortgage (NASDAQ:MTGE) -- have all reported earnings. All missed Wall Street's expectations.
But that doesn't mean consistent, high-yield stocks are out altogether. High-yield equity REITs may be a much better substitute for mREITs in a volatile interest-rate environment.
Buildings, not mortgages
Equity REITs such as Realty Income (NYSE:O) and Health Care REIT (NYSE:WELL) hold physical real estate. Realty Income invests primarily in commercial real estate, whereas Health Care REIT holds senior living and medical properties. Think hard assets, not paper.
American Capital Agency holds mostly agency-backed mortgages. Annaly Capital Management and American Capital Mortgage hold non-agency and commercial mortgage securities. Think paper, not hard assets.
Equity REITs also have the benefits of lower leverage. So although Realty Income's 5.2% yield or Health Care REIT's 4.7% yield might not rival the mREITs' double-digit yields, equity REITs also have much better dividend stability. Not to mention, they move much more slowly in reaction to interest-rate fluctuations, preserving your investment in rising or falling interest-rate environments.
Realty Income's business model
Realty Income is in the business of buying standalone commercial properties -- gas stations, single-tenant retail buildings, and theaters -- and leasing them on long-term contracts. The business model is as simple as it comes: The company raises money at one rate and invests in real estate with the goal to earn a higher rate.
And it does so with long-term capital, so it doesn't have the exposure to short-term interest-rate jumps like the mREITs do.
What makes Realty Income great is that it's structured with dividend growth in mind. When it signs a long-term lease, it includes annual price increases indexed to the inflation rate or the tenant's annual sales. In just the past year, the company increased rents 1.3%, allowing for several dividend increases to shareholders as more income flows to the bottom line.
Its history of good acquisitions also supports the dividend and dividend growth. Adjusted funds from operations (a measure of its ability to pay dividends) grew 15.4% per share in the past 12 months. Its monthly dividends are 20% larger now than one year ago. If history is any guide, investors who buy today at a 5.2% yield will see much bigger dividends as Realty Income completes new acquisitions.
Make a mint on health care
Health Care REIT is on a tear, acquiring new hospitals and medical buildings which it leases back to medical-care companies, doctors, and patients. In the last quarter, Health Care REIT acquired new senior housing facilities in the U.K., completed another purchase for 38 housing communities, and closed on a new purchase of hospitals.
Like Realty Income, Health Care REIT is in the business of raising cash cheaply to deploy funds in higher-yield real estate.
All this acquisition activity has been great for the company's dividend. Health Care REIT increased its guidance for normalized cash flow from operations to $3.74-3.80 per share next year, easily supporting its dividend, which tallies to $3.06 per year, per share. The company now yields 4.6% at the current price.
Health-care REITs have a natural advantage in that medical buildings are not as commoditized as other real estate assets. A hospital tenant can't simply move to a new location at the drop of a hat, giving landlords pricing power to raise rents over time. A combination of rising rents and good acquisitions has propelled 30% growth in the quarterly dividend in the past 10 years.
The Foolish bottom line
Equity REITs offer greater share price stability at the cost of a lower dividend. However, over time, both Realty Income and Health Care REIT have consistently grown payouts to shareholders, all while mREITs have slashed their distributions. Investors who want yield with less volatility should give a second look to lower-yielding equity REITs for income for the long haul.