Annaly Capital Management (NYSE: NLY) is offering investors a huge 10.4% yield. The mortgage real estate investment trust (mREIT), however, comes with more risk than dividend investors may realize. If you are attracted to Annaly, you should consider mREIT alternative Broadmark Realty Capital (NYSE: BRMK) instead. Here's what you need to know.
Look at that yield!
There's no question that mREIT Annaly Capital Management is offering a mouthwatering yield. However, investors need to step back here and take a look at history to understand the problem with focusing on the current yield.
Indeed, Annaly’s yield has hovered around the 10% mark for most of the company's public life. But dividend yields aren't static -- they move as the stock price changes. And that's a big problem.
Because Annaly's dividend has been cut and raised over the years, its stock price has risen and fallen in such a way to keep the yield at around 10%, give or take.
Since 2010, the dividend and stock price have been on a generally downward course. To be fair, this isn't unique to Annaly. The normal mortgage REIT business model pretty much guarantees this type of dividend and share price volatility.
Essentially, mortgage REITs take on debt to buy mortgages. Their profit is the difference between the interest they earn and the interest they pay. As market conditions change, they have to adjust their portfolios, and the dividends they can support change, too.
The truth is, Annaly is a fairly well-run mortgage REIT. It's just that most dividend-focused investors would be better off avoiding traditional mortgage REITs because of the inherent volatility in their dividends and share prices.
There's one mortgage REIT that does things a little differently. Broadmark is what is known as a hard money lender, which means it provides cash directly to builders. The builders use the properties they are working on as collateral to back the loans.
In a worst-case scenario, Broadmark takes over a project and either sells it off or completes it. But that's not very common, because Broadmark usually loans out only about 60% of what it expects a completed project to be worth. That allows a huge amount of room for error before Broadmark is at risk.
And perhaps just as important, Broadmark avoids using debt. It prefers to fund deals with the cash it has on hand, rolling over maturing loans into new ones. If it needs cash quickly, it can tap a line of credit and then sell stock to permanently finance the deals it's inked. But that's not something it has had to do just yet -- it ended the first quarter with zero long-term debt.
The long-term goal, meanwhile, isn't to simply play the spread like a typical mortgage REIT. Broadmark is looking to grow its loan book and, thus, increase its ability to pay dividends over time. That said, the company IPOed at a pretty awful time, coming to market via a blank-check company in late 2019. The coronavirus pandemic led to construction delays and resulted in Broadmark cutting its monthly-pay dividend by 25%. Given the uncertainty, being overly cautious was probably the right course of action.
However, at the start of 2021, it increased the dividend by roughly 16.5%, as construction markets got back on track. Assuming future pandemic impacts are limited, there's no reason to expect a repeat of the 2020 dividend cut. In fact, it's far more likely that the dividend grows over time as Broadmark's portfolio grows.
Indeed, it's probably best to look at Broadmark as a quasi bank looking to expand its footprint rather than a traditional mortgage REIT that's just playing the spread. The yield is currently around 8%. While that's lower than what you'd get from Annaly and many other traditional mortgage REITs, the inherent risks are very different.
The bottom line
If dividend consistency is important to you, say because you're retired and use dividend income to help fund your living expenses, traditional mortgage REITs are generally not a great option for you. Annaly falls into that category. However, hard money lender Broadmark Realty Capital, while lumped in with mortgage REITs, operates with a very different business model.
With 2020 in the rearview mirror, the differences here, including an avoidance of debt and direct relationships with borrowers, should start to shine through. And as this mREIT grows its loan book, it's logical to expect more dividend growth to come. If the high yields of mREITs are drawing your attention, Broadmark Realty should probably be the one most dividend investors choose.