Mortgage real estate investment trusts (mREITs) often provide investors with big dividend yields. But they can be complex investments to understand and, at times, very volatile. If you'd rather play things a little bit safer but still want a big yield, Broadmark Realty Capital (NYSE: BRMK) could be the mREIT for you. Here's why.
The mREIT business
The first thing to understand about Broadmark is that it isn't a typical mortgage real estate investment trust (mREIT). mREITs usually own portfolios of mortgages pooled together into collateralized mortgage obligations (CMOs). These securities trade like bonds, with their values rising and falling over time based on market conditions. Moreover, mREITs typically use leverage, backed by the securities they own, to increase returns (these companies earn the spread between the yield on their portfolio and the interest rates they pay for loans).
That leverage works great -- until there's a market dislocation that can result in the value of CMOs falling, reducing an mREIT's loan collateral and causing its lenders to ask for more cash. It's like a margin call for individual investors and, while not frequent, such demands often arrive at the worst possible times. Two notable examples were during the COVID-19 bear market and the 2007 to 2009 housing-led recession.
In addition, mREITs are generally operated with an emphasis on total return. That means the return you get as an investor contemplates the reinvestment of the dividend over time. If you're looking to live off of your dividend income, the math doesn't work out quite as well. The last decade, for example, has seen interest rates falling, which means mortgage rates have been falling as well. So many mREITs have been forced to cut their dividends, which has led to share price declines.
If you reinvested dividends, you'd come out ahead total return-wise, but if you spent them, you'd be suffering with share price declines and a falling income stream. Putting some numbers on that, Annaly Capital Management (NYSE: NLY) has seen its shares fall roughly 60% over the past 10 years as its dividend was trimmed 65%. That's terrible, noting that the REIT's yield has been over 10% for most of that decade since the stock fell along with the dividend. But, on a total return basis, the return an investor received, assuming dividends were reinvested, was still 35% over that span.
A better model
Throw all that out the window when you look at Broadmark. This REIT is what's known as a hard money lender, which means it provides loans to construction companies in the process of building properties. These are short-term loans backed by the assets being built.
Generally speaking, Broadmark will look to lend only about 60% or so of the value it believes a property will sell for once completed. That means the final sales price can fall materially before Broadmark takes a hit. While the short-term loan nature of the business means it constantly must find new projects to back, Broadmark has a 10-year history (most of it as a private company) of doing that successfully. In fact, many of its customers are repeat borrowers, with over 60% of its third-quarter loans coming from people with whom it has previously worked.
So Broadmark is a mortgage REIT because it makes loans, but it isn't using the typical business model you see in the space. And there's another, very important difference: It doesn't use leverage. There's zero debt on its balance sheet, which means it doesn't have to worry about margin calls or trying to earn enough to pay its interest costs. The biggest obligation it has to worry about is its monthly dividend payment, which currently results in a 7.1% yield.
That's not as high as other mREITs, but it's also not as risky, either. To be fair, Broadmark trimmed its dividend by 25% in early 2020 because COVID-19 resulted in construction delays for its customers. That's unfortunate but understandable and, just as important, not a real statement about the ongoing nature of its business, which tends to be fairly predictable. Indeed, the construction situation has materially improved as the year has progressed.
Less yield, more safety
Broadmark has only been public for a year or so, meaning it has a relatively short history to go on. While this is a realistic issue to be concerned about, it has an over 10-year history behind it. Add in the fact it doesn't use debt, and there's actually a lot like here. Yes, its 7.1% yield will likely fall short of many mREITs. But its goal is to pay out a consistent dividend over time, not total return, which changes things materially for investors.
If you are looking at mREITs as a way to boost the income you generate, you may end up disappointed by what can be a very volatile niche of the REIT sector. Broadmark's approach, however, is "built" from the ground up for dividend investors looking to live off the income their portfolios generate.