Dividend Watch: The Problem with Mortgage REITs

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

One niche area of the real estate investment trust (REIT) space that has been getting particular attention of late is mortgage REITs. The impressive yields these companies offer are the clear reason for this focus, as it is hard to find 10% yields anywhere else in the market. That said, these companies have a habit of cutting their dividends. This is not the type of investment that you want to own if a predictable income stream is your goal.

The Cockroach Theory
There's a saying on Wall Street that problems are like cockroaches: there's never just one. Dividend cuts definitely have a habit of acting like cockroaches. That's why it's often wise to sell a company, or to at least pay particularly close attention to a company's business, after just a single dividend cut. In fact, you should be paying extra attention to the details after a company with a long history of yearly dividend increases holds its disbursement steady.

So, with multiple dividend cuts already creeping out from under the cupboards in the mortgage REIT space, there is little reason to expect the trend to stop. In fact, this trend can be particularly painful for income-oriented investors even though the share prices of some mortgage REITs haven't plummeted as you would normally expect after a dividend cut; typically a sign that a cut was expected.

Chimera Investment Corp.
For example, Chimera Investment Corp.'s (NYSE: CIM) quarterly dividend peaked at $0.18 per share in October, 2010. It was cut by a penny the next quarter, three cents the following quarter, and another penny the quarter after that. The dividend held at $0.13 for two quarters before resuming its slide, falling two cents for two quarters and then another two cents. At its current rate of $0.09, the dividend is half of what it was in October, 2010.

Chimera is a low priced stock, trading in October 2010 at around $4.50 a share and, more recently, around $2.50. The largest decline in price came after the first dividend cuts. So, not only did investors see their income streams fall materially, they also lost half of their investments. This isn't a stock you want to be holding on to if dividend income is the goal. Sure, the yield has remained enticing throughout the dividend decline, but that's only because the share price has fallen, too.

<img src="http://media.ycharts.com/charts/dde2a25accfda7fce25fccd01af8225b.png" />

CIM data by YCharts

Annaly Capital Management
Annaly Capital Management (NYSE: NLY) is another cautionary tale. Annaly's quarterly dividend peaked at the start of 2010 at $0.75 per share. It has since bounced around a little bit, but has, at the end of the day, fallen to $0.50. That's a 33% cut. While the REIT's share price has held up better than Chimera's, fluctuating between $16.50 and $18.50, the drop in the dividend is material. While the yield is still high relative to other securities, you have to ask yourself if it is worth the risk.

<img src="http://media.ycharts.com/charts/22fc40b33cb613f11b5d0bdb64f02f37.png" />

NLY data by YCharts

Anworth Mortgage
Anworth Mortgage Asset (NYSE: ANH ) is yet another example of the mortgage REIT following the dividend cutting trend. However, a quick look at the company's dividend history shows that it has a pretty volatile distribution, with a high of $0.54 in the third quarter of 2001 and a low of just $0.02 for five consecutive quarters from the fourth quarter of 2005 through to the fourth quarter of 2006. More recently, the REIT has cut its quarterly dividend in each of the first three quarters of 2012 after cutting the dividend twice last year.  

<img src="http://media.ycharts.com/charts/fa04c85f76835690d4edfc25d6d26100.png" />

ANH data by YCharts

The Allure of 10%
I would lying if I said that a 10%-plus dividend yield wasn't enticing. Who wouldn't want to get the historical return of the stock market year in and year out in the form of a steady dividend. In fact, I've purchased numerous REITs with yields in the 10% range. They have been, and remain, some of my best investments. However, I purchased REITs with histories of increasing their dividends, not REITs that have histories of dividend cuts.

To be fair, many mortgage REITs increase dividends in good times and cut them in bad times, passing the good and the bad on to shareholders. This isn't a bad dividend model and, in fact, is very similar to the approach taken by many European companies. However, it is difficult, if not impossible, to plan your life around a variable dividend that is likely to be cut at the very moment you are looking for stability.

If the money you are investing in mortgage REITs is meant to supplement other income, then variable dividends from an aggressive investment may be perfectly acceptable to you. However, if you are looking for a stable income stream, you would be better served by investing in lower yielding, but more predictable, options.


ReubenGBrewer has no positions in the stocks mentioned above. 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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