Annaly Capital is the biggest U.S. mortgage REIT by market capitalization
Annaly Capital (NLY) is a self-managed REIT that invests in a variety of real estate–related securities, including pass-through certificates, collateralized mortgage obligations, callable agency debt, and other mortgage-backed securities (MBS). Recently, Annaly has focused on the agency product, and 90% of its portfolio has been dedicated to Fannie Mae, Freddie Mac, and Ginnie Mae mortgage-backed securities. However, Annaly’s charter gives it the freedom to allocate up to 25% of its portfolio in non-agency product. The company also invests in various agency-backed structured products such as floaters and inverse floaters, which provide tailored interest rate exposure.
The mortgage REIT strategy can generate outsized returns
As you can see from the chart above, mortgage REITs like Annaly can generate outsized returns over the long haul. Part of this is due to their tax structure. They don’t pay U.S. federal taxes, so there isn’t the double taxation effect that most corporations have to deal with. It’s important to remember that this period of outperformance takes place during what we can consider one of the greatest bond bull markets of all time. Still, as a REIT, the company has to pay out 90% of its earnings as dividends, so you often get “paid to wait.” In other words, you have a great dividend yield to compensate you while you wait for the stock to take off.
The REIT landscape
There are two basic flavors of mortgage REITs—agency REITs and non-agency REITs. Agency REITs invest in mortgages guaranteed by the government. Non-agency REITs don’t, which means they take credit risk. The best comparable for Annaly is American Capital Agency (AGNC), which is also an agency REIT with a lot of exposure to fixed-rate agency MBS. Some REITs, like MFA Financial (MFA) or Capstead (CMO), invest primarily in agency adjustable-rate mortgages. Finally, non-agency REITs like Redwood Trust (RWT) invest in non-guaranteed MBS, so they bear credit risk.