A Still-Safe 17.3% Yield
Business is good for mortgage real estate investment trusts (mREITs) nowadays.
Regular readers have heard about mREITs before. These firms raise cash through debt issues, then buy up pools of higher-yielding mortgages. Profits come from the difference between those two rates, otherwise known as the “spread.”
And in the current post-financial-crisis environment, these businesses have become money-making machines. Low interest rates allow mREITs to borrow cheap. At the same time, yields on long-term mortgages remain quite high.
Take Arlington Asset Investment Corp (NYSE:AI), for example. This firm owns a huge portfolio of residential mortgages. The company collects monthly interest income on these loans, which come with the full backing of the “Uncle Sam” or government-sponsored agencies.
In the latest reported quarter, Arlington earned six-percent interest on its loans, so it earned a three-percent spread. If the company borrows $6.00 for every $1.00 of equity, that comes out to roughly a 18% return on equity.
Analysts figure Arlington will stay consistent next year. The Federal Reserve doesn’t seem to be in a rush to raise interest rates. The yields on long-term bonds, meanwhile, continue to rise. If it pays out $2.20 next year, that’s a 17.2% dividend yield (based on a $17.50 stock price).
So, if you own Arlington today, you’ll probably earn more than 35% in dividends over the next two years. That’s incredible. Of course, your exact return could shift depending on interest rates, but this remains one of the biggest payouts available right now.
I don’t expect this yield to remain a secret for long. Right now, shares trade at a discount because mREITs are out of favor with investors. But, with such a big dividend up for grabs, traders will likely start piling in, boosting the stock price.
To be clear, you can’t call mREITs a slam dunk. Borrowers, even on loans as safe as mortgages, do default on occasion. The profit spread between where these businesses can borrow and lend swings wildly. That said—and this point is worth repeating—these mortgages have the full backing of U.S. government agencies like Fannie Mae and Freddie Mac. In addition, Arlington executives have also done a good job hedging out interest rate risk.
Bottom line: Low interest rates have crushed savers, but some lenders are still finding ways to profit. And with distributions topping 20%, high-yielding mortgage REITs warrant further investigation. Arlington Asset Investment Corp represents one of my favorites.