If you are looking for dividend income, you might find Annaly Capital Management's (NYSE: NLY) huge 14.2% dividend yield attractive. But you'd be better off buying UDR's (NYSE: UDR) much smaller 4.6% yield. Here's what you need to know before you end up adding a serial dividend cutter to your portfolio and pass up a historically high yield from a reliable dividend grower.
Annaly: Not all REITs are boring
The chart below tells an important story when comparing Annaly Capital to UDR. Annaly's dividend has been cut multiple times over the past decade, while UDR's has trended slowly higher.
If you are trying to live off the income your portfolio generates, suffering through multiple dividend cuts is kind of counterproductive. A high starting yield doesn't make up for the reduction in income. And, notably, Annaly's stock price has tracked its dividend lower, so investors have also suffered a loss of capital.
UDR Dividend data by YCharts
To be fair, Annaly isn't a bad REIT -- it's just meant for large institutional investors, like pension funds, that focus on total return (which assumes dividend reinvestment) and asset allocation. That's very different from what most small dividend investors are looking for. This dynamic is not going to change because Annaly is a mortgage REIT, not a property-owning REIT like UDR.
Mortgage REITs are a highly complex niche of the broader REIT sector. They own portfolios of mortgages that have been rolled up into bond-like investments. Those investments, often called something like a collateralized mortgage obligation, trade all day and are heavily impacted by interest rate moves. But because they are collections of mortgages, the housing market, mortgage rates, mortgage repayment trends, and mortgage defaults all have an impact, too.
There's a lot going on, and most investors, particularly conservative income investors, won't be well served investing in Annaly. It's too complicated, and the dividend just isn't reliable.
UDR is boring, but that's a big plus
In comparison to Annaly, UDR will put you to sleep. It owns apartment buildings, which provide a basic human necessity (shelter). It has specifically built a portfolio that is diversified by both market and apartment quality. In this way, no one segment of its business will have an outsize impact on its performance.
What really sets UDR apart from Annaly is that UDR's dividend has been increased annually for 15 years. Those who look far enough back will notice that UDR cut its dividend around the time of the Great Recession. That move, however, was driven by a reset of the company's historical business model (buying "fixer-uppers"), not the recession.
Essentially, UDR exited lower-quality apartments in favor of focusing on more desirable assets with longer-term growth appeal. The apartment landlord made itself better, and the dividend has been growing steadily since the change.
Rising interest rates, meanwhile, have increased UDR's operating costs. And a wave of apartment construction has put pressure on occupancy and rental rates.
So UDR isn't firing on all cylinders today, which is why the stock price is down and the 4.6% dividend yield is near 10-year highs. That's an opportunity for long-term investors looking for a reliable income stream, noting that with an adjusted funds from operations (FFO) payout ratio of around 75% or so in 2023, there's little risk that the dividend is going to be cut even in the face of the current headwinds.
Annaly's dividend just isn't worth the risk
Annaly's dividend is high on an absolute level, but so, too, is the risk. Most dividend investors will be better off elsewhere. UDR, meanwhile, has a dividend that has grown reliably since management shifted its business approach toward owning more attractive properties. The yield is historically high right now. This is an opportunity for long-term-focused income investors to add a well-run REIT and an attractive dividend stream.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
