Income investors have been dealt a challenging hand as a result of the pandemic. The Federal Reserve cut interest rates to zero percent and has been buying longer-term Treasuries and mortgage-backed securities as a way to effectively drive down long-term rates further.
While corporate bonds are paying miserly rates, some stocks are paying quite well. Here are a couple of real estate investment trusts (REITs) with a twist that can reward investors handsomely.
A way to profit from changing government housing policy
New Residential Investment Corp. (NYSE:NRZ) is a mortgage REIT with an origination business. The mortgage REIT part of the company owns mortgage-backed securities and mortgage-servicing assets. The origination business has historically focused on nonqualified mortgages, which are not guaranteed by the government. This business can be volatile, and when the credit markets have a hiccup, it can cause losses.
New Residential’s combination of these two activities helps smooth out the earnings stream. Mortgage originators tend to do well when interest rates fall because they pick up a lot of refinancing demand. On the other side of the coin, heavy refinancing activity is a negative for mortgage-backed securities and mortgage-servicing rights. But the Federal Housing Finance Agency recently made a policy change that should drive more origination volume to the nonqualified mortgage market and help New Residential’s origination business.
The company is also a bit of a value stock, trading a little under book value, which means the market is attributing little value to the origination business. New Residential is looking at various ways to unlock the embedded value in this segment. Unlike most mortgage originators, the company pays a REIT-type dividend, which gives it a yield of 7.7% at Wednesday’s prices. Investors are being paid to wait in this case.
A way to profit from rising lumber prices
Anyone who has visited a home improvement store for a weekend do-it-yourself project knows that the price of lumber is way up. One company that stands to benefit from this is Weyerhaeuser (NYSE:WY). It owns or operates 10.7 million acres of timberland in the United States and holds long-term licenses for 14.1 million acres in Canada. The company also has manufacturing operations, with 19 lumber mills, six mills for oriented strand board, 10 factories for engineered wood products, and 18 distribution facilities.
Rising lumber prices are a function of elevated demand for home construction. The supply of homes for sale is at record lows, according to the National Association of Realtors. Lumber’s increase is driving up estimates for Weyerhaeuser, which is expected to earn $3.51 per share, compared to $1.29 a year ago.
Note that much of this increased profitability will translate into higher dividends. Weyerhaeuser’s dividend policy is to pay a regular quarterly dividend plus a variable dividend based on full-year results. The company intends to pay 75% to 80% of funds available for distribution (FAD) as dividends.
Last year, FAD totaled $1.2 billion. If you grow last year’s FAD by the expected EPS growth rate, you would be looking at FAD of $3.3 billion. Taking 75% of that FAD figure and dividing by shares outstanding gives you an expected dividend for 2021 of $3.38. Since the base dividend is $0.68, the special dividend in January 2022 could be something like $2.70. At recent levels, between the base dividend and the variable dividend, stockholders could earn 9%.
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