With interest rates close to 0%, finding a return can be a difficult endeavor. US Treasuries pay a whopping 0.94% in exchange for locking in your money for 10 years. One of the few industries that offers consistent performance is the Real Estate Investment Trust (REIT) industry.
REITs have many different business models. There are Office REITs, Apartment REITs, and Data REITs. The two highest yielding REIT sectors are typically retail REITs and mortgage REITs. Real estate income (NYSE: O) is a leading retail REIT, while AGNC investment (NASDAQ: AGNC) is one of the best mortgage REITs. But what is the best dividend-paying stock?
Realty Income Increased Dividend Despite COVID-19
Realty Income (aka Monthly Dividend Company) is the classic real estate investment trust. The company owns properties and then rents them out to tenants under long-term leases where the tenant covers almost all of the expenses. These types of retail REITs are referred to by the REIT industry as “triple net” leasehold REITs. Typically, triple net lease REITs have long-term relationships with companies that are relatively insensitive to the economic environment. Major tenants of Realty Income include convenience stores, drug stores and dollar stores. The company’s biggest tenants include Walgreen’s, 7-11, General dollar, and FedEx. Despite the COVID-19 slowdown, perceptions are improving steadily and the company said it collected 94% of rents in September. This business model allowed Realty Income to continue to pay dividends during the crisis and even increase them in June.
AGNC’s investments are guaranteed by the government
AGNC Investment is a mortgage REIT, which is a different animal compared to traditional REITs. Mortgage REITs do not own properties and do not charge rent. Mortgage REITs are more similar to banks. They hold real estate debts (like mortgages). If you’ve recently refinanced your home with your local bank, chances are your loan ended up in a mortgage-backed security on a mortgage REIT’s balance sheet. AGNC invests almost exclusively in mortgage-backed securities issued by Fannie Mae and Freddie mac. These titles are guaranteed by the US government.
Credit risk versus interest rate risk
AGNC and Realty Income present different types of risks. Realty Income carries a lot of credit risk, which is the risk that tenants may not be able to pay their rent. If the tenants of Realty Income cannot pay, the REIT must still cover its interest payments. On the other hand, AGNC Investment’s portfolio consists mainly of mortgage-backed securities guaranteed by the State. This means that if the borrower cannot make their mortgage payments, the government will ensure that AGNC always receives their principal and interest.
That said, the absence of credit risk does not mean that AGNC is risk free. Its business model involves an interest rate risk and a liquidity risk. These problems caused AGNC Investment to suffer heavy losses and reduce its dividend in the spring. When the economy is bad, AGNC takes advantage since interest rates stay low. When the economy improves, interest rates will rise, which means a more difficult environment for AGNC.
Realty Income pays a monthly dividend and has a yield of 4.7%. The company is part of the Dividend Aristocrats, an elite group of companies that have increased their dividends each year consecutively for at least 25 years. This is a record of stability that few other companies can claim. AGNC Investment is another monthly payer that has a dividend 9.3% yield. Problems with COVID-19 and margin calls forced the company to reduce its monthly dividend from $ 0.16 to $ 0.12. in April. AGNC admitted on its call for second quarter results that the cut was probably unnecessary in retrospect.
So which one is the best dividend shares? It depends on how much you value consistency. Realty Income has a stable business model that has survived multiple economic cycles. AGNC Investment has a higher yield, but the dividend has been more volatile. Much will depend on how COVID-19 plays out. The tenants of Realty Income have managed to pay their rent; However, the company is exposed to the struggling gym and movie theater segments. If the economy recovers quickly, Realty Income will benefit more than AGNC, as credit risk will work in Realty Income’s favor and interest rate risk will work against AGNC. On the flip side, if the economy enters another prolonged recession, AGNC’s government-guaranteed portfolio is likely to outperform, especially as the Federal Reserve actively supports its assets.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.