Mortgage real estate investment trusts (mREITs) are not like their property-owning cousins, and that changes how you have to look at companies like Chimera Investment (NYSE: CIM) and Broadmark Realty Capital (NYSE: BRMK). But even the difference between these two mREIT names is pretty notable. Here's what you need to know before buying either of these mortgage REITs and which one is the safer risk/reward opportunity today for income investors.
1. Income or total return?
One of the most important things to understand about an mREIT like Chimera is that its goal is total return, which assumes the reinvestment of dividends. To put a number on that, over the past decade, the REIT's stock price is down around 40%, but its total return is nearly 120%. That includes a disastrous 2020, in which the stock price was cut in half.
The reason for the difference is that the dividend was put back to work in the shares throughout, allowing for compounding. If you didn't reinvest those dividends, you'd be sitting on a big capital loss and, as we'll discuss in a second, a dividend cut. This means investors looking to live off their dividends probably won't be happy with a mREIT -- or at least not a typical one like Chimera.
Broadmark's goal is a bit different, it wants to generate a reliable and, hopefully, growing dividend stream. So, dividend yield is a more important figure for Broadmark and dividend investors.
2. The business model
The key difference between Chimera and Broadmark is in their portfolios. Chimera basically owns a collection of collateralized mortgage loans. It amplifies its buying power with loans backed by its portfolio and makes the spread between its funding costs and the interest on the loan portfolio.
The leverage involved here, however, can lead to trouble, since the loan portfolio is the collateral. In turbulent times, like in 2020, the value of the portfolio can drop, leading lenders to ask for more collateral. It's comparable to an individual investor getting a margin call and highly undesirable. Basically the fear of just such an event led to a 40% dividend cut at Chimera in 2020.
Broadmark's business is a bit more mundane. It makes short-term loans to builders, getting repaid when projects are completed or sold. While the REIT did cut its dividend 25% in 2020, it was because construction projects were disrupted by the coronavirus pandemic. There was never a fear lenders would hit the company with a margin call.
In fact, Broadmark specifically avoids the use of debt, simply rolling the cash from paid-off loans into new ones. If it wants to grow the size of its portfolio, it sells shares to raise new cash to invest. With business getting back to normal at this point, Broadmark announced a 17% dividend increase in February. (For reference, Chimera has yet to increase its dividend.)
3. The yield thing
With that backdrop, it's now time to consider the yields. Chimera's dividend yield is a huge 10.4%. That's actually a pretty normal level for the mREIT, but remember, that total return is the end goal, not dividend income. So investors can't really expect to live off of the income they receive here. The yield stays elevated because the stock price adjusts along with the dividend, including falling when the dividend gets cut.
Broadmark's yield is a still-impressive 8%, which looks less desirable until you understand that the goal of the mREIT is to create a reliable income stream for investors by acting as a lender to construction companies -- effectively working like a sort-of bank in many ways. In other words, if you're a dividend investor, there's really no comparison: Broadmark's lower yield is the more attractive option.
4. A caveat to consider
But dividend investors shouldn't run out and buy Broadmark just yet. While its business model is vastly different from that of a typical mREIT, like Chimera, Broadmark has only been public for about a year or so. It has a roughly decade-long history behind it, but its public life hasn't been so great, given that it IPOed just before the coronavirus pandemic.
On the one hand, Broadmark has proven its ability to muddle through major industry upheaval. But on the other, investors still don't really know how the company will perform when times are more normal because it hasn't operated as a public company during normal times.
While it's easy to argue that surviving the pandemic proves the strength of Broadmark's model, investors shouldn't buy the stock without keeping a close eye on its performance as its business recovers. For better or worse, management still has to prove the REIT can live up to its goals.
The clear winner
It should be pretty obvious that Broadmark, despite a lower yield, is the better option for income-oriented investors. This, however, is not necessarily a negative mark against Chimera. It's just that Chimera's not really an income stock in the traditional sense, despite a big yield. In the end, most investors will likely be better off with Broadmark, while only a select few will find Chimera appropriate for their investment portfolios.