Picture the stock market as a giant sandbox. Hidden under all that sand is income in the form of dividend yield. You have to crawl and search and sift, and sometimes you find something you think is income, but it turns out to be sand.
Not all income is created equal. Some is safer than others. Some income can be deceiving.
Many more income offerings have turned up in recent years as interest rates destroyed bonds as a source of dividend yield. However, low interest rates also created opportunities for many other kinds of investments. Things like business development companies (BDCs), mortgage REITs and preferred stocks have all benefited from lower rates for different reasons.
Just like any investment, however, income investments require further examination. You have to inspect the gem you find in that sandbox to make sure the dividend is sustainable.
Income Plays Yielding 8% or More: Arbor Realty Trust Inc (ABR)
Arbor Realty Trust Inc (ABR) has several offerings of preferred stock worth looking at, but first we have to understand what ABR is all about.
ABR is involved in what is commonly known as “structured finance.” It makes bridge and mezzanine loans that are somehow connected to real estate, such as being secured by it. It also recently made agency platform acquisitions that will permit it to originate and service mortgage loans using the agency model.
As part of the big acquisition, ABR will collect $55 million annually for servicing a $225 million portfolio, on top of all its regular business. That’s great news for preferred stockholders, because it helps solidify the company’s solvency.
The 8.25% Series A Cumulative Preferred is trading at around $25.60. That’s 2% above par, and the resulting yield is 8.2%. The 7.75% Series B Cumulative Preferred is trading around $25.49. That’s 2% above par, and the resulting yield is 7.6%. The 8.5% Series C Cumulative Preferred is trading at $26.08. That’s 4% above par, and the resulting yield is 8.1%.
Income Plays Yielding 8% or More: UBS ETRACS Wells Fargo Busn Dev Co ETN (BDCS)
Business Development Companies, or BDCs, are special tax-advantaged structures created by the federal government. The idea is that earnings are not taxed as long as 90% of net income is paid out to shareholders. The reason for this structure is the government wants these entities to take some risk, and invest capital into fast-growing companies.
That capital is necessary — and expensive — because a company may be very successful and is growing, but doesn’t have the money it needs to meet the growth. It also can’t get enough financing from banks. So BDCs borrow money at low rates, and lend it out at higher rates.
Since individual BDCs can vary in performance and type of investment, I suggest the UBS ETRACS Wells Fargo Busn Dev Co ETN (BDCS). This way, you get a basket of BDCs yielding 8.4%.
Income Plays Yielding 8% or More: Starwood Property Trust, Inc. (STWD)
Starwood Property Trust, Inc. (STWD) is a commercial mortgage REIT that pays 8.5%.
It can pay that big dividend because of its very successful diversified business. It originates floating-rate first and mezzanine mortgage loans, with average terms of only 3 to 5 years. The loan-to-value ratio is extremely conservative at only 61%.
Amazingly, after making almost $17 billion in loans, it has exactly ZERO realized loan losses.
It invests in collateralized mortgage-backed securities, as well. It provides specialized servicing for troubled loans. It also originates $5 million to $20 million fixed-rate mortgages and then sells them into bundles with multiple dealers. It also owns real estate.
The net leveraged returns on all of these plays leads to the generous dividend. The entire portfolio is well-diversified by region and by property type, and they are extremely cautious about investing their capital. Only 3%-4% of inquiries become actual deals.
As of this writing, Lawrence Meyers was long STWD stock.
