High Yields from Two Top Mortgage REITs

12/20/2017 5:00 am EST

Focus: FUNDS

Carla Pasternak

Editor, The Income Investor

The commercial real estate market, in particular, enjoyed strong sales volumes in the past few years. In fact, commercial property lending was the fastest growing loan category in the U.S. banking industry during the first half of the year, notes Carla Pasternak, editor of Dow Theory Letters' The Income Investor.

Commercial real estate loans are generally for a relatively short term of 5 to 10 years, in contrast to 30 years for residential mortgages. That means they are refinanced at regular intervals.

The debt underwriting market is competitive, but lending rates remain high and creditor standards are stricter than before the 2008 financial crisis.

As interest rates likely rise over the next five years, lending rates are expected to increase as well. Lenders should benefit, as they profit from the difference between higher long-term lending rates and lower short-term borrowing costs on capital that funds their loans.

Unlike equity REITs, mortgage REITs generally don't own properties. Instead, mortgage REITs are more like bond fund managers than landlords. They invest in debt by originating or buying mortgage securities that they manage in a loan portfolio. Here's a look at my two top picks among mortgage REITs.


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Apollo Commercial Real Estate Finance (ARI) originates subordinate and first-mortgage loans on commercial properties across the U.S. and the U.K. Almost 90% of the 56 loans in the $3.6 billion loan portfolio are at floating rates, positioning the company for higher interest rates.

Earnings have grown by nearly 8% annually over the past five years, in line with portfolio growth. For the first nine months, per share earnings of $1.23 were 10.8% higher than the year-ago period, thanks to higher interest income on floating rate loans. Earnings are expected to ratchet up 15% next year, after taking an 11% hit in 2017, in part on a 30% increase in outstanding shares in an effort to raise capital. 

Dividends of $0.46 per share have been paid every quarter for the last two years. That gives the shares an annual yield of nearly 10% at today's share price ($1.84/$18.69). Trailing 12-month earnings of $1.86 give a 99% payout ratio, which is not uncommon for a REIT. Most of the dividend qualifies as ordinary income, taxable at your marginal tax rate.

Blackstone Mortgage Trust (BXMT) originates and buys senior mortgage loans collateralized by properties in North America and Europe. The $10.7 billion portfolio of 111 senior loans is secured by assets in major markets, with over 40% located in New York or California. With 92% at floating rates at September 30, the trust is positioned for higher interest rates.

Earnings have grown a robust 25% annually on average during the past five years, driven by loan origination growth. The dividend has grown an average 8% a year during the last three years, in line with earnings. The current quarterly dividend of $0.62 per share annualizes to $2.48, giving a yield of nearly 8% at today's share price ($2.48/$32.46).

Estimated earnings of $2.54 per share in 2017 give a 98% payout ratio. Over 90% of the dividend is taxable as ordinary income, making the shares suitable for a tax-sheltered account.

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