Why Will Popular Real Estate Investment Trusts Cut Dividends in 2012?

REITs were introduced by the government as a way for investors to receive income from property, rather than relying on Rightmove to find their next buy-to-let. Their tax treatment has traditionally been a very strong draw, with the requirement that 90% of the trust’s income must be paid out to unit holders. This means that REIT trust managers were under a legal obligation, making these trusts very popular with sophisticated investors. Since then, much analysis has taken place into yields from REITs and the sustainability levels for the larger real-estate companies.

Two Examples

Annaly Capital Management Inc has come under scrutiny. Its business lies in generating net income for its investors from investment securities and dividends received from subsidiaries. The company owns various mortgage securities that are guaranteed by America’s largest government agencies – Fannie Mae, Freddie Mac and Ginnie Mae. This means that these mortgages are regarded as low-risk bonds, in a way comparable to Treasuries. Market risk is mitigated through the subsidiary companies which trade, hold and clear in capital-distribution securities.

Annaly shares trade on the NYSE at around $17 a share, with a low of $14.05 and a high of $18.79. The annual yield from dividends lies at 13.50%, with generous distributions. As the company trades with agency-backed paper, there’s a risk of long-term bonds rallying and creating a flattened yield curve. This could result in leveraged loans becoming less attractive. As cash liquidity has become drier in the market, investors are playing the ‘wait and see’ game to assess how cash flow and asset coverage react in the current dampened economic climate.

The latest dividend paid on Jan 26th was $0.57, which was a decrease on the previous three quarters, which averaged at $0.62. As the stock price is relatively stable and sitting within its annual high and low points, it suggests that this year’s dividend will decrease, given the central bank’s position on interest rates. However, the investment still remains favourable.

Another investment company, Chimera, trades at about $3 per share, with a yearly low at $2.38 and a high at $4.34. The P/E ratio is 5:57 and EPS is $0.55, with a dividend yield hitting 14.4%. It’s a wholly-owned subsidiary, managed by FIDAC – the Fixed Income Discount Advisory Service – and invests in residential mortgage loans and real-estate securities based on property such as that found every day on Rightmove. Unlike its parent company, Annaly, it doesn’t invest solely in agency-backed paper and has some assets that aren’t covered by government guarantees. This allows it to realise higher returns in favourable market conditions.

Expectations of the Economy

The Federal Reserve has stated that it anticipates the economy will continue to slowly grow in 2012, but threats from within the US and internationally at a macro level still necessitate caution. The European situation is also likely to affect fixed-income instruments and their liquidity.

Government Economic Measures

Further measures to stimulate the sluggish economy and ease levels of inflation will probably result in the near-term rates staying low. Today we’re looking at a flattening yield curve, when maturities have comparable yields. Analysts have pointed to Treasury market influences which have counteracted each other. Better economic numbers than expected should have raised yields, but the continuing European problems and the short/long term Treasury swaps have driven rates down.