An Income Smorgasbord
From a handful of REITS to California bonds to companies raising dividends, you can find investments with sure-thing cash returns.
So much is going on in the markets, particularly as they relate to income investors, that it seems silly to focus on just one issue. So here's a quadruple-header -- four items for the price of one.
Let's start with real estate investment trusts, which have performed just miserably for more than a year. In particular, let's focus on REIT dividends. Property-owning REITs lost 38% last year and have already dropped another 33% so far in 2009 through February 20.
As you can imagine, times are tough for real estate companies. Late last year, in response to requests from a number of REITs, the Internal Revenue Service ruled that the trusts could pay up to 90% of their dividends in stock for the rest of 2008 and all of 2009. The move allows REITs to conserve cash during these hard times (they still must distribute 90% of their net income to shareholders, but the payouts don't have to be entirely in cash).
![https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-200-80.png](https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-320-80.png)
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Widely owned REITs, such as Simon Property (symbol SPG) and Vornado Realty Trust (VNO), are now distributing mostly shares, as are many smaller trusts. For investors, this is problematic for three reasons. First, cash is a lot more valuable than shares that continue to lose value. Second, the issuance of the new shares dilutes current shareholders' stake in the REIT. Third, there's a tax snare. For tax purposes, the value of a dividend paid in shares is considered the same as a dividend paid in cash. You could owe tax for 2008 or 2009 on "income" you cannot spend unless you sell the stock at an ever-sinking price.
The REIT industry favors the flexible approach to paying dividends because it can aid both strong and weak REITs. The ones with high debt loads can buy time until they are able to obtain credit on more-favorable terms. Healthier REITs can accumulate cash, with which they can buy properties at cheap prices from desperate sellers.
Because REIT shares have cratered, many now sport double-digit current yields. But a payout is essentially meaningless if only a sliver of it is in the form of cash. Better to invest in REITs that are still paying all dividends in cold cash and insisting that they will continue to do so. Two possibilities are Corporate Office Properties Trust (OFC) and Realty Income (O). At its February 24 close of $26.96, Corporate Office yielded 5.3%. Realty Income yielded 9.1% at its closing price of $18.65. Not surprisingly, these two were among the best-performing REITs of 2008.
By the way, the IRS's dividend provision also extends to preferred stock, although the National Association of REITs says no preferred issuer has yet paid dividends in shares. Such a move would truly be an act of desperation and would probably kill the market for new REIT preferred stocks, one of the industry's best sources of capital in these trying times.
Annaly Capital Management (NLY) is a REIT that's doing just fine, thank you. On January 29, it paid a 50-cents-a-share dividend, for a total of $2.08 per share over the past four quarters. Based on the stock's February 24 close of $14.69, that's a yield of 14.1%. Moreover, Annaly's ten-year annualized return is a staggering 15.9% (over that same period, Standard & Poor's 500-stock index has lost money).
Annaly's success is a testament to a simple business formula and the glories of low interest rates. Annaly invests in packages of moderate-size government-guaranteed or quasi-government- guaranteed mortgages, profiting from the spread between its own cost for short-term debt (which has been cheap for most of its history) and the mortgage income, which is mostly from fixed-rate loans.
With Fannie Mae and Freddie Mac now under official federal control, Annaly's credit quality looks even better than it did two years ago. As long as the feds are willing to back mortgages, Annaly will have high-quality assets to buy and sell. And even if Annaly were to have trouble raising new capital to buy more mortgages, it wouldn't face a crisis; it merely wouldn't be able to grow.
The big risk for Annaly shareholders is the possibility of short-term interest rates rising faster than long-term rates. The last time Annaly's shares tanked, in 2005, the Federal Reserve Board was in the early stages of a multi-year campaign of raising short-term rates to combat incipient inflation. When that happens, Annaly generates less income and it cuts its dividend.
So a burst of inflation -- and the Fed's response to it -- would be painful for Annaly shareholders. But that doesn't seem to be in the cards now. Instead, the nation is mired in a deep recession, and prices have been flat the past year. As such, the Fed is likely to keep short-term interest rates at roughly zero for the indefinite future.
But long-term bond yields could rise in response to a seemingly limitless supply of new Treasury borrowing to finance stimulus spending, bank rescues and other expenditures. That would presumably lead to higher mortgage rates. Annaly would be well positioned to buy higher-yielding fixed-rate government-guaranteed loans while it paid low rates to borrow. Under this scenario, the stock could easily revisit the low $20s, at which it traded a year ago.
Now, to California bonds. Gov. Arnold Schwarzenegger recently welcomed Lance Armstrong back to professional cycling at the Tour of California. Then the governator and the state legislature patched together enough tax increases and spending cuts (including layoffs and furloughs) to produce a budget. But California will need a miracle as monumental as Armstrong's surviving cancer to avoid even more massive borrowing (the state already has $57 billion worth of bonds outstanding). Standard & Poor's rates California bonds single-A, the lowest of any state. As a result, California has to pay nearly 6% on new long-term bonds, even those secured by general tax revenues.
Several investment advisers I've spoken with recently say they favor municipal bonds over corporates and Treasuries -- "but not California" bonds. The fact is, though, that California bonds are performing quite well so far this year. Among single-state muni bond funds with enough mass to have their own Morningstar categories, long-term California funds are the year's best performers, having returned an average of 6.3%.
The strong performance suggests that some investors may have overreacted in talking about California bonds as if they came from Baja California. Bill Larkin, of Cabot Money Management, in Salem, Mass., notes that California general-obligation bonds are yielding about the same as high-grade corporates, which don't offer the same tax benefits. But, he adds, "Corporate business models are failing left and right, while state GOs have no defaults that I can remember." Tim Courtney, of Burns Advisory Group, in Oklahoma City, says that investors who have all of their muni money in California should diversify with bonds issued in other states. "But if you've been holding California municipals, definitely continue to hold them," he says.
The new budget raises California's already daunting state income tax rate to a maximum of 9.55%. That should give well-to-do California residents still more incentive to buy state bonds. A cycle is at work here, though it's certainly not a virtuous one: More borrowing depresses the state's credit rating, which leads to higher bond yields. That in turn generates more interest from investors, whose buying props up the value of the bonds and sometimes pushes them up.
At any rate, buy only California GOs or revenue bonds from the state's university systems. Even water and sewer revenue bonds in California are questionable if the issuer is in a location where every third house is in danger of foreclosure or abandonment.
Stocks and dividends. This is a subject for a longer story. But before you overreact to all the dividend cuts that have been announced in recent weeks, think about who is cutting and why -- and who is not.
I discussed REITs earlier. Banks must safeguard capital to survive or to get off the government dole. Energy companies are cutting because lower oil-and-gas prices and sagging demand are denting profits. Some utilities are conserving cash in anticipation of big costs for environmental mandates.
But lots of health, consumer-products and diversified companies aren't cutting dividends. Many are raising them, even if they are otherwise conserving cash by suspending share buybacks and slowing capital spending. There are no guarantees in investing, but it hardly seems likely that companies such as Abbott Laboratories (ABT), Coca-Cola (KO) and Corn Products International (CPO) will raise dividends one moment and rescind the increase the next.
These stocks have been suffering along with virtually everything else this year as the bear market has spread from financials and energy to nearly all sectors. But advisers and fund managers say they expect cash payouts to matter more again once the market stabilizes. Manny Weintraub, an independent money manager in New York City, says he's been buying not only Coke and Pepsi, but also tech stocks such as Microsoft (MSFT) and Texas Instruments (TXN) because they offer unusually high yields (nearly 3%) relative to their histories. Weintraub says rational investors will seek out sure-thing cash returns first while they wait for share prices to rebound in anticipation of an eventual end to the recession.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
-
Visa Is the Worst Dow Stock Wednesday. Here's Why
Visa stock is down sharply Wednesday after the credit card company came up short of revenue expectations for its fiscal Q3.
By Joey Solitro Published
-
Another Analyst Moves to the Sidelines on Tesla Stock After Earnings
Tesla stock is spiraling Wednesday after the EV maker's big earnings miss and Wall Street has been quick to weigh in. Here's what you need to know.
By Joey Solitro Published
-
Stock Market Today: Stocks Slip Ahead of Mega-Cap Earnings
GE Aerospace shares soared after earnings while United Parcel Service stock slumped.
By Karee Venema Published
-
Stock Market Today: Mega-Cap Tech Rallies to Drag Markets Higher
Markets focused on upcoming earnings from Magnificent 7 stocks rather than chaos in D.C.
By Dan Burrows Published
-
Stock Market Today: Stocks Tumble After Spectacular Global Internet Crash
Market participants rushed out of risk assets to end a wild week of trading.
By Dan Burrows Published
-
Stock Market Today: Dow Sinks 533 Points as Big Banks, Mega Caps Slump
Goldman Sachs and Apple were two of the worst-performing blue chip stocks on Thursday.
By Karee Venema Published
-
Stock Market Today: Semis Get Slammed and Blue Chips Bounce
The potential for more curbs on tech sales to China set off a rotation into blue chips.
By Dan Burrows Published
-
Stock Market Today: Dow Spikes 742 Points After UnitedHealth Earnings
The S&P 500 and Nasdaq also scored wins Tuesday albeit with much smaller gains than the blue chip Dow.
By Karee Venema Published
-
Stock Market Today: Dow Adds 210 Points as Apple, Goldman Hit New Highs
A big rally in blue chips and some dovish Fed speak boosted the equities market Monday.
By Karee Venema Published
-
Stock Market Today: Markets Bounce Back on Rate-Cut Optimism
The latest readings on consumer sentiment and inflation helped lift the odds of the Fed easing in September.
By Dan Burrows Published