Will These 5 REITs Maintain Their High Dividends?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As much of the Fed's quantitative easing strategy, or QE3, has involved placing large amounts of capital into agency mortgage backed securities, what will happen to REITs when this round of quantitative easing ends? In this article, I will discuss why REITs, and particularly Annaly Capital (NYSE: NLY), will still produce strong dividend yields in both the short and the long run.

While it is likely that most of 2013 will see low interest rates for mortgage REITs, it is still uncertain as to just exactly how long the Fed will continue this bond buying program in order to stimulate the U.S. economy.

This could signal a continued downward pressure on bond yields that are earned by REITs, resulting in lower asset yields, lower net interest rate spreads, and ultimately lower dividend distributions. However, I feel that those mortgage REITs that are well diversified will still be able to continue to provide high dividend payouts.

Annaly Capital reported a lower net interest spread and asset yields in the fourth quarter of 2012. Because of well-managed expenses by those at the helm, the company's expenses actually decreased by 36% throughout the past year.

Annaly is working hard to further diversify its overall portfolio. One move in this direction is the company's acquisition of CreXus Investments for $13 per share, or a total value of $872 million. This represents a major step forward by Annaly in its commitment to directly invest in commercial real estate assets.

The all-cash offer by Annaly Capital to purchase the remaining shares of CreXus is just a part of the company's overall capital allocation strategy that is not only aimed at strengthening the firm's commercial real estate platform, but also to diversify its investment portfolio.

Annaly presently pays its shareholders an annual dividend of $1.80 per share, equating to a dividend yield of roughly 12%. The firm's fourth quarter 2012 net income of just over $700 million represents a significant increase over the company's net income of $445 million in the fourth quarter of 2011. This is likely one of the catalysts responsible for Annaly's shares rising more than 7% year-to-date in 2013. 

Other REITs of interest

Even with a drop in its net income, CYS Investments (NYSE: CYS) is still providing the potential for both income and growth to its shareholders. Although CYS posted a fourth quarter 2012 net loss of more than $41 million, the REIT reported just over $58 million in net investment income during that same time.

Since then, the share price has dropped -- especially in light of the vast difference in performance between 2012's third and fourth quarters. CYS' third quarter net income was more than $240 million, or $1.46 per share.

Many see this fall in share price as a real buying opportunity, especially in light of the fact that the company is still paying its shareholders a $0.40 per share quarterly dividend, which equates to a dividend yield in excess of 13%. On top of that, CYS announced at year-end 2012 that the company was also paying its shareholders an additional special dividend of $0.52 per share. In addition, CYS also announced at the end of 2012's fourth quarter that it was declaring a Series A Preferred Stock cash dividend of $0.484375.

American Capital Agency (NASDAQ: AGNC) has had higher asset yields, due in large part to the rise in its interest yielding assets during the first quarter of 2013. This comes despite the low interest rate environment created by the Fed. This company is believed by some to be a pre-payment protected portfolio.

In terms of constant prepayment rate (CPR), American Capital ended 2012 with an average of 10%, giving this REIT one of the lowest constant prepayment rates in the overall agency mortgage REIT sector.

The firm has used a unique strategy for keeping its spreads up. Rather than directly trading mortgage securities, the company uses a separate market to cash in on what is referred to as the dollar roll market. Here, American Capital agrees to defer taking delivery of mortgages until a later time in return for the collection of a finance charge.

American Capital has a number of pluses, including a five-year annual revenue growth rate of over 135% (including a recent 1-year revenue growth of over 69%), a P/E ratio of 12.07, and a gross margin of 100%. This REIT pays an annual dividend of $5.00 per share, which equals a dividend yield of over 15.5%.

Another REIT that could be of interest is Chimera Investment (NYSE: CIM). Although the firm states earnings per share of only $0.55, it has still managed to pay its shareholders a $0.36 dividend, yielding over 12%. One word of caution here, though, is that Chimera is yet to officially report its earnings since the third quarter of 2011. The reason for this, the company cites, is accounting errors that are related to earnings from bonds that were bought at a discount. Even with this lack of information, though, the company's shares are up over 12% year-to-date in 2013.

One REIT that may have fallen out of favor of late is ARMOUR Residential (NYSE: ARR). This is due in part to the company's higher leverage -- although this REIT may still be worth a look given the increased stability in the housing market, as well as improving fundamentals.

More than 75% of ARMOUR's income comes from regular mortgage payments. The company's free cash flow from operations, minus one-time gains or losses on property sales, has risen over the past three years. Because of ARMOUR's decline in share price of over 8% since the second quarter of 2012, the shares are currently trading at a medium valued level. This REIT is still holding its own though, providing a dividend yield of 14.4%, and an expected rise in share price over the next 12 months of more than 14% as well.

The bottom line

CYS Investments' share price drop, along with the additional special dividend of $0.52 per share, presents a good buying opportunity for investors. American Capital's stellar numbers, including a P/E ratio of 12.07 and dividend yield of over 15.5%, make it a strong pick among this group of REITs. My least favorite of this group is Chimera Investment, since it has yet to officially report earnings since the third quarter of 2011. Investors should use caution when buying Chimera. ARMOUR Residential, with its 14.4% dividend yield, is certainly worth considering. I expect ARMOUR Residential will perform well over the next six to twelve months.   

I believe the best pick out of this group is Annaly Capital. The company has a history of paying large dividends to its shareholders - a feat that is not likely to change any time in the near future. Given its forward momentum in diversifying its portfolio, along with its substantial decrease in expenses, I feel that Annaly Capital is still a good option for REIT investors who are seeking both growth and income in the short and the long run. 

jordobivona has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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