Annaly or AGNC: Which 16%-Yielding Mortgage REIT Is the Better Buy?

Annaly Capital (NYSE: NLY) has a huge 16.4% dividend yield as of this writing. AGNC Investment's (NASDAQ: AGNC) yield is an even higher 17%. Those are massive yields, but investors need to understand what they are really buying with both of these mortgage real estate investment trusts (REITs). Here's why Annaly Capital may be a slightly better choice, but still not a great pick for an income-focused investor.

Annaly and AGNC are well run

From a big-picture perspective, both Annaly Capital and AGNC Investment are well-respected mREITs. They do what they do well, but they are both fairly complex investments to understand. Despite the massive dividend yields they offer, dividend investors seeking consistent, if not growing, dividends will likely be disappointed by these stocks. Indeed, each company has a highly volatile dividend history, with long periods in which the dividend has declined.

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If what you are looking for is a dividend you can rely on to pay your bills in retirement, neither Annaly nor AGNC are likely to be a good stock for you. In fact, if you spent the dividends, you would be left with less income and less capital, because their stock prices have generally followed the dividend higher and lower over time. However, if you reinvested dividends, both have produced much more impressive long-term results, even after accounting for the current price drawdown.

All in, AGNC Investment and Annaly Capital are total-return investments that require reinvesting dividends. However, if you are looking for exposure to the mortgage market, perhaps for diversification, both are worth a close look.

Annaly has a slight edge over AGNC

The core of both Annaly Capital and AGNC Investment is their portfolios of mortgage securities. Essentially, they issue stock and take on debt to buy mortgages that have been pooled together into bond-like securities. The goal is to earn the spread between operating costs and the yields collected.

That said, the value of the mortgage securities that each mREIT owns is affected by interest rates, just like any other bond. So rising rates lead to a decline in the value of the mortgage securities these companies own. The stocks are declining because each company's value is essentially the value of the mortgage-backed securities it owns. If you think rates are going to continue heading higher, you may want to wait before buying either Annaly Capital or AGNC Investment.

That said, there's a subtle difference between these two companies. AGNC Investment is focused entirely on owning mortgage securities. There is essentially no diversification in its business model, which shows up in the slightly higher yield. Investors are simply demanding more for the risk they are taking.

Annaly Capital goes a step beyond mortgage securities by owning mortgage servicing rights as well. Essentially, it handles homeowners' payments, collecting a small fee on each transaction it processes. This creates a reliable income stream for Annaly Capital. However, it remains a relatively small part of the business compared with the mREIT's mortgage investment operations. Annaly's mortgage servicing rights are not enough to alter the big-picture risks investors face from owning mortgage-backed securities, but they could make the stock more attractive than AGNC in a rising-rate environment.

Know what you own with AGNC and Annaly

AGNC and Annaly are both complex investments that only more active investors should consider. And it is important to understand the volatile dividend histories here, because neither stock is likely to be appropriate for an income investor to own. However, if you want exposure to the mortgage sector, either option could be appropriate. That said, Annaly's slightly more diversified business will probably give it the edge with most investors right now as interest rates rise.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.