With a yield hovering near 16% at recent prices, mortgage real estate investment trust (REIT) Annaly Capital Management (NLY 0.59%) is one of the most eye-catching dividend stocks in the market today.
A yield this high may seem alluring, especially when the broader market is down and inflation is running rampant. But the risk isn't necessarily worth the reward, especially when there are far safer high-dividend stocks to choose from -- like Innovative Industrial Properties (IIPR -0.82%). This cannabis REIT's dividend yield may be half of Annaly's, around 8%, but its risk is far less, too.
Here's a closer look at both companies and why Innovative Industrial Properties is the better buy.
Annaly's near term doesn't look bright
Annaly Capital Management is a prime example of why you should be suspicious of ultra-high yields. Its yield is often above 10% -- and over the past 10 years, it's cut its dividend by over 51%.
Annaly invests in two main types of mortgages. The first is mortgage-backed securities (MBS) insured by government agencies, which make up roughly 67% of its portfolio holdings. The mortgage loans collected in these securities generally have less risk because if a borrower stops paying, the government will cover those payments instead of Annaly. The REIT also invests in non-agency-backed mortgages and has a special arm for mortgage servicing.
Rising interest rates are extremely challenging for mortgage REITs like Annaly because they eat into net interest margin. This margin, which is the difference between its interest income and income expenses, makes up the bulk of the REIT's earnings. Annaly's net interest margin has fallen consistently quarter over quarter and its earnings are in the red. Its earnings available for distribution per share are still positive, meaning the company has enough coverage for its extremely high dividend yield. But it may not be able to sustain that for long if things don't improve quickly.
Fluctuating interest rates also impact the bond and securities markets, weakening demand for Annaly's product, as investors seek higher yields in less volatile assets. Less demand diminishes the value of Annaly's assets and negatively impacts its book values. In the third quarter of 2022, Annaly's book value fell 15% from the quarter prior. Considering the macroeconomic environment doesn't look much better at the start of 2023, these challenges will continue to weigh on the company.
Invest in this leading cannabis REIT instead
Annaly is likely facing another dividend cut if things don't start improving considerably in the near future. Rather than risk it all for a juicy yield, investors can earn slightly less while taking on less risk and volatility with Innovative Industrial Properties (IIP).
IIP is a cannabis REIT that owns, develops, and leases industrial properties to existing medical marijuana operators. The company uses a special sale-leaseback agreement to buy properties and rent them back to the tenant using a long-term net lease. This creates reliable income for IIP while giving the tenant much-needed liquidity in a highly regulated industry.
As I said, no company is without risks. Innovative Industrial Properties is battling multiple tenant defaults largely thanks to inflationary pressures and impacts from rising interest rates on top of a class action lawsuit. But even with these issues, it has continued to deliver market-beating returns and exceed analysts' expectations for earnings.
Its properties remain 100% occupied, and 97% of its rents have been collected as of the year ended 2022. It's also flush with cash, has no debt maturities until 2026, and has overall low debt exposure. The REIT has been an excellent dividend payer over the years, raising its dividend by over 1,000% since its IPO in 2016 and providing a total annualized return of 38% over the past six years.
That's far better than the 2.5% annualized return Annaly has provided during that same period. I've owned IIP for many years and plan on holding this high-yield dividend stock for the long haul.
