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More isn’t always better. Sometimes less is: Vigorously exercising an hour a day strengthens the body. Vigorously exercising three hours a day weakens it.
Income can be viewed through a similar lens. Sometimes the intelligent course is to take less. You may go for the high yield and initially benefit. But in time that high yield can lead to a weakened income portfolio.
I refer to the immoderate habit of yield chasing. A recent spate of emails solicited my opinion on high-yield investing. For some reason, double-digit yields are attracting more attention these days.
Energy is a case in point; it’s always been a deep well-spring for income investors. But one e-mailer was interested in pumping the handle a little harder. Specifically, to call forth a 26% yield in Sandridge Mississippian Trust I (NYSE: SDT), a royalty trust with interests in oil & gas fields in Oklahoma.
Sandridge paid a $0.50 quarterly distribution per unit last month, which annualizes to $2. The attraction is both apparent and enticing: In less than four years, a Sandridge investor could receive his initial investment of $7.80 per unit back in distributions alone.
Unfortunately, there’s a catch. The Sandridge properties are depleting at an accelerating rate – 20% quarter over quarter in the fourth quarter of 2012. The distribution is highly vulnerable and has been continually reduced over the past three years. In short, Sandridge units are priced for further distribution reductions, which are sure to follow.
Cross Timbers Royalty Trust (NYSE: CRT) is the moderate alternative. It owns interests in oil and gas properties in Oklahoma, Texas, and New Mexico. Its 8% yield won’t stimulate the salivary glands, but its steady distribution (paid monthly) and long operating history (22 years) ensures restful nights. Thus, Cross Timbers benefits both portfolio and body.
Real estate investment trusts (REITs) are also prone to excessive yield reaching. The highest yields – 11%, 12%, even 14% – are found among mortgage REITs, which borrow short-term at a floating rate to invest in long-term fixed-rate mortgage-backed securities (MBS).
One e-mailer sought more insight to New York Mortgage Trust (NASDAQ: NYMT), a mortgage REIT that invests in government-guaranteed MBS. New York Mortgage yields over 14% on its $1.08 annual dividend.
These mortgage REITs earn the spread between their cost of funds and the returns on their MBS portfolio. To goose returns, they employ leverage – and frequently a lot of it: New York Mortgage’s debt exceeds its equity by a multiple of nearly 15.
To be sure, leverage is a terrific wealth-enhancing tool in today’s low-rate environment. How long that environment will last is anyone’s guess. As rates move higher, New York Mortgage’s borrowing costs will move higher too, while the value of its MBS portfolio will fall. Should this unsettling paradigm materialize, dividend reductions will follow.
Commercial REITs are the moderate alternative. These companies own the physical property. They are the actual landlords, not mere financial conduits like the mortgage REITs.
Gladstone Commercial Corporation (NASDAQ: GOOD) is the moderate choice. It owns 85 commercial properties in 21 states from Connecticut to Texas.
Gladstone is a model of reliability The dividend has been raised four times over the past 10 years, and has never been reduced. At the current rate of $0.125 per share per month, investors can expect to $1.50 over a year. At the current market price, the payout produces a moderate but solid 8.5% yield.
So go for less in your income portfolio, especially if more today has a high probability of becoming less tomorrow.
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