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Income investors are in a difficult position. Interest rates remain close to zero, which means that yields on fixed income securities have fallen in recent years. As for equities, the rally to all-time highs in the market caused the average dividend yield of the S&P 500 the index drops to around 1.3%. That’s why investors looking for higher income levels can look to High Yield REIT.
Real estate investment trusts, or REITs for short, generally offer high dividend yields because they are required to pay out almost all of their profits to shareholders. This translates into high payout ratios, but also high returns that are regularly several times higher than those of the broader market.
And in the case of the three stocks we’ll look at below, that’s certainly true, given that all three stocks outperform the market, even when compared to other REITs. They are:
- Annaly Capital management (NYSE:ONLY)
- Apollo commercial real estate financing NYSE:ARI)
- Omega Health Investors (NYSE:OHI)
REIT: Annaly Capital Management (NLY)
Source: Shutterstock
First on our list of REITs is Annaly Capital Management, which is a REIT that invests in financial assets rather than physical assets.
To this end, Annaly purchases and holds agency mortgage-backed securities, agency-less residential mortgage assets, residential mortgages, commercial mortgages and other related real estate investments.
The trust was founded in 1996, employs 180 people, is expected to generate approximately $ 1.8 billion in revenue this year, and trades with a market capitalization of $ 12.3 billion. These numbers make Annaly one of the largest REITs in the market.
We see Annaly struggling to grow from current earnings levels, both given that she has experienced declining earnings in recent history, as well as an unfavorable environment for leveraged REITs such as than Anna. Annaly borrows short-term money and then lends it long-term through her investments in securities, so the spread she can reach between short-term and long-term rates is absolutely critical.
When rates fall – as they were in the recent past – leveraged investment stores like Annaly find it difficult to maintain profitable spreads. With interest rates still very low and a relatively flat yield curve, we continue to see Anna struggling to grow and put her annual profit growth at -0.2%.
Annaly is in huge debt, as you would expect for a mREIT. However, Annaly has worked in recent years to use the proceeds of the securities to pay off her debt, and her net debt has grown from $ 114 billion in 2019 to $ 60 billion at the end of September. However, this also corresponded to a decline in assets, which fell from $ 131 billion to $ 77 billion during the same period. Annaly will still have a lot of debt because that’s how the mREIT model works, but it can also lead to volatile profits.
The stock’s payout ratio is currently around 80%, which is acceptable for a REIT given that the trust must return substantially all of its profits to shareholders. Annaly has reduced her payments several times over the past decade, so this is something to keep in mind. But the current payout looks sustainable and the stock is currently showing a massive 10.2% return.
Apollo Commercial Real Estate Financing (ARI)
Source: Shutterstock
Next is Apollo Commercial Real Estate Finance, a REIT which is somewhat similar to Annaly in that it is an mREIT, not a company that purchases physical properties. Apollo creates, acquires, invests and manages commercial loans, subordinated financings and related real estate debt instruments.
The trust was founded in 2009, generates approximately $ 270 million in revenue and trades with a market capitalization of $ 2.1 billion.
Like Annaly, Apollo has struggled to increase its income in recent years. The business model requires borrowing and investing the product, so the spread is paramount. With interest rates still quite low, Apollo has recorded relatively stable profits in recent years, excluding a significant drop in 2020 linked to the pandemic. We expect normalized earnings for 2021.
Nonetheless, given the challenges for the industry, we see a profit contraction of 7.2% per year in the coming years as Apollo struggles to increase earnings per share. Industry headwinds with interest rates, as well as a rapidly increasing number of stocks are expected to limit Apollo’s earnings growth.
Apollo’s dividend is still very high relative to earnings, as it has consistently paid over 100% of earnings over the past decade, filling the gap with newly issued common stock. The trust dividend has been reduced several times to account for this, and the current payout is close to 100% of projected earnings for this year, so we believe there may be further reductions underway.
Still, Apollo is showing a current yield of over 9%, so as a pure income stock it is still very attractive.
REIT: Omega Healthcare Investors (OHI)
Source: Shutterstock
Finally, we have Omega Healthcare Investors, a REIT that invests in long-term healthcare facilities, such as skilled nursing and assisted living facilities. Unlike Apollo and Annaly, Omega owns physical properties and operates with a triple net lease structure that minimizes operating costs for Omega. It is active all over the United States and also has a small presence in the United Kingdom.
Omega was founded in 1992, generates approximately $ 935 million in annual revenue and trades with a market cap of $ 7.2 billion.
We expect modest growth for Omega, reaching 2% per year for the foreseeable future. The trust benefits from favorable demographic trends in terms of population growth in older segments. These are Omega’s customers who need some sort of assisted living facility, providing a surge of demand that we hope will last for decades. This helps Omega produce reliable cash flow and over time has generated growing profits and dividends which we hope will continue.
Omega has slowly increased its balance sheet in recent years, taking a little extra leverage when an acquisition comes along. Omega’s balance sheet is leveraged, but that is to be expected from REITs. We don’t see Omega’s leverage as an issue, and its payout ratio is around 80% for this year. With this in mind, we consider the dividend yield of 8.9% to be secure for the foreseeable future.
Final thoughts
REITs can offer investors tremendous income generation, but they come with their own set of risks. Financial REITs, such as Annaly and Apollo, offer a unique set of growth and risk characteristics compared to physical asset REITs, such as Omega.
All three REITs offer huge dividend yields, as well as varying levels of growth.
As of the publication date, Bob Ciura does not have (directly or indirectly) any position in any of the stocks mentioned in this article. The opinions expressed in this article are those of the author, subject to the InvestorPlace.com Publishing Guidelines.
Bob Ciura worked at Secure dividend since 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. His articles have been published on major financial websites such as The Motley Fool, Seeking Alpha, Business Insider and more. Bob received a BA in Finance from DePaul University and an MBA with a concentration in Investments from the University of Notre Dame.
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