Although last week was a solid reminder that stocks don't move up in a straight line, Wall Street is still enjoying another banner year. Within the last month, the iconic Dow Jones Industrial Average, benchmark S&P 500, and growth stock-fueled Nasdaq Composite all romped to fresh, record-closing highs.
But while investors have gravitated to the growth stocks that have powered this bull market to new heights, they've often overlooked or neglected the sectors and industries flush with value stocks and dividend payers that can make patient shareholders richer over the long run.
In particular, Wall Street appears to be ignoring ultra-high-yielding real estate investment trusts (REITs). When I say "ultra-high-yield," I'm talking about stocks with yields that are at least four times higher than the benchmark S&P 500 -- ergo, above 5.64% (1.41% yield for the S&P 500 X 4).
At the moment, two phenomenal ultra-high-yield REITs look ripe for the picking, with respective valuations that haven't been this cheap in years.
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Realty Income: 5.8% yield
The first REIT that opportunistic income seekers can confidently pounce on is premier retail REIT Realty Income (O 0.64%). Realty Income has paid 646 consecutive monthly dividends, increased its payout for 106 straight quarters, and is currently yielding an S&P 500-trouncing 5.8%.
The primary reason Realty Income's stock has been in a funk since the summer of 2022 is the Federal Reserve's monetary policy. The most-aggressive rate-hiking cycle since the early 1980s has sent Treasury yields soaring. When investors can generate 5% annualized yields from short-term Treasury bills with practically no risk to their principal, they'll often overlook low-volatility REITs -- even when they're proven winners, like Realty Income.
The other concern for Realty Income has been the possibility of a U.S. recession taking shape. Factors that include a historic decline in M2 money supply and the longest inversion of the yield curve in modern history suggest that a downturn in the U.S. economy may not be far off. That's a bit worrisome for REITs that predominantly lease to retailers.
On the flipside, recessions have a way of working themselves out rather quickly. While there have been 12 recessions since the end of World War II, only three reached the 12-month mark, and not a one surpassed 18 months in duration. By comparison, most periods of economic growth stick around for multiple years, if not a full decade.
What makes Realty Income so special is its exceptionally diversified commercial real estate (CRE) portfolio. As of late January, it owned in excess of 15,450 CRE properties, of which 89% of its total rent was believed to be "resilient to economic downturns and/or isolated from e-commerce pressures."
Approximately 40% of the company's annualized contractual rent can be traced back to grocery stores, convenience stores, dollar stores, home improvement stores, and drug stores. In other words, these are stores consumers are going to visit in any economic climate because they carry basic necessity goods. Despite its CRE portfolio having representation in 86 industries, the company's foundation is laid on industries that are insulated from economic hiccups.
Realty Income's management team also deserves credit for continuing to diversify its CRE asset portfolio beyond retail. Realty Income completed two deals in the gaming industry over the last two years, closed a $9.3 billion acquisition of Spirit Realty Capital in January, and announced a joint venture with Digital Realty in November that'll see the two companies develop build-to-suit data centers. Yes, even Realty Income has a way to take advantage of the artificial intelligence (AI) revolution.
Best of all, Realty Income is cheaper than it's been in at least 10 years, relative to its future cash flow. Whereas the company has averaged a multiple of 17.6 times cash flow over the trailing-five-year period, shares can be picked up right now for 11.6 times consensus forward-year cash flow. That's dirt cheap for an industry-leading retail REIT.
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Annaly Capital Management: 14.3% yield
The second ultra-high-yield REIT that long-term-minded investors can pounce on with confidence is mortgage REIT Annaly Capital Management (NLY 1.47%). Annaly has averaged around a 10% yield over the last 20 years, and its board has declared $25 billion in dividend payouts since becoming a public company in 1997.
The abysmal performance of Annaly's stock over the last two years can be boiled down to the Fed's hawkish monetary policy and the historic inversion of the yield curve.
With regard to the former, Annaly borrows money at lower, short-term lending rates and uses this capital to purchase higher-yielding, long-term assets, such as mortgage-backed securities (MBS). This is how the "mortgage REIT" industry earned its name. With the nation's central bank aggressively tackling above-average inflation by hiking interest rates, it's sent short-term borrowing costs substantially higher and shrunk Annaly's net-interest margin -- i.e., the average yield of assets owned less its average borrowing cost -- and book value.
The historically long inversion of the yield curve isn't helping, either. When short-term Treasury bills have higher yields than long-term Treasury bonds, it provides additional pressure to Annaly's net-interest margin.
However, when things appear their darkest is often when mortgage REITs are at their most attractive from an investing standpoint.
History is most definitely on Annaly's side. While it can be tough to pinpoint exactly when the yield curve will return to normal, history shows that the Treasury yield curve spends a disproportionate amount of its time sloped up and to the right. This is to say that long-dated bonds sport higher yields than those maturing in one year or less. When the yield curve normalizes, Annaly's net-interest margin should expand.
I'll add that the pace of change from the nation's central bank matters, too. Although mortgage REITs perform best during rate-easing cycles, what's even more important is that the Fed telegraphs and slow-steps its moves. This gives mortgage REITs like Annaly adequate time to adjust their portfolios to maximize profit.
Another catalyst for Annaly is the Fed shifting away from MBS purchases. When the nation's central bank began its quantitative tightening cycle, it stopped purchasing MBS. With less competition for high-yielding MBS, Annaly should be able to meaningfully increase the average yield on the assets it holds.
Annaly Capital Management's portfolio is also heavily weighted toward agency assets. "Agency" securities, which are protected by the federal government in the event of default, comprise $65.7 billion of Annaly's $74.3 billion portfolio. Having this protection allows the company to lever its investments in order to boost its profit potential.
Annaly is currently valued at 6% below its book value, which is the cheapest it's been, based on year-end readings, since 2021.
