Given ultra-low interest rates and the lack of high-yielding fixed income instruments for income oriented investors, I have constructed a portfolio that yields 14.5%, in addition to the upside potential being offered by each stock within the portfolio.
The three stocks considered in the portfolio are mortgage Real Estate Investment Trusts (mREITS), which are considered highly complex corporate structures. Therefore, investors must look at their future potential, particularly in the light of the Fed’s anticipated exit from the Agency MBS markets.
Plenty of drivers for this mREIT
The first stock considered for this portfolio is Annaly Capital Management, Inc. (NYSE:NLY). It happens to be the largest mortgage real estate trust in the US, investing in Agency mortgage backed securities. The company is very well-managed, which is why it is well-prepared for the Fed’s exit from the Agency MBS markets.
While the company’s investment portfolio offers little diversification, its acquisition of CreXus Investments will make low double-digit returns available to Annaly Capital Management, Inc. (NYSE:NLY). This is particularly important when the Fed has put significant pressure on long-term rates through its bond buying programs. Further, the company went from an internally managed structure to an externally managed structure. This, I believe will save the company on its compensation expense. Additionally, the presence of commercial real estate loans in the company’s portfolio makes the book value less sensitive of changes in the interest rates.
Credit: Annaly Capital Management, Inc. (NYSE:NLY)
Believe in California
MFA Financial, Inc. (NYSE:MFA) is another mortgage REIT. However, it’s classified as a hybrid mREIT as it has investments in both Agency and non-Agency Mortgage-Backed Securities (MBS).
The reason why MFA Financial, Inc. (NYSE:MFA) is a compelling investment is because of its non-Agency holdings. A large proportion (almost half) of its non-Agency MBS is from the California region. The region is blessed with low mortgage rates, coupled with rising multi-family rents, limited housing supply and capital flows into own-to-rent purchases. This has led to faster price home appreciation in the region (over 17% appreciation in Alameda). Increased home prices will lead to higher MBS yields causing the company to report higher returns during the second quarter.
The company offers a dividend yield of 10.1% with stock price appreciation potential of 9.6%.
Diversification to benefit this mREIT
Western Asset Mortgage Capital Corp (NYSE:WMC) is another hybrid mortgage REIT. Besides, investing in residential Agency and non-Agency MBS, the company is also invested in commercial mortgage backed securities and other asset backed securities. So, this wide variety of assets provides the company with enough diversification to survive the volatility in interest rates.
The company is offering a sustainable dividend yield of 20.3% with the stock price that is expected to report 12.4% appreciation. I believe the dividend rate is sustainable because its prior quarter’s cash dividend coverage ratio comes out to be 1.9 times, which means it had sufficient financial muscle to cover its dividends from its operating cash flows in the past.
Looking at the future, the management at Western Asset Mortgage Capital Corp (NYSE:WMC) expects its net interest income of the second quarter of increase 2.2% it the interest rate increase 50 bps. Since the rates have already gone up, you can expect the company to generate higher returns, making the dividend continuity trouble-free.
Conclusion
Equal concentration of each stock will lead the portfolio to yield 14.5% in dividends. However, the aforementioned portfolio is composed up of stocks that are highly dependent on changes in interest rates. Therefore, this portfolio should be considered as one part of a broader retirement portfolio.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Building 14.5% Yields With mREITs originally appeared on Fool.com and is written by Adnan Khan.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
