Which High-Yield Financial Stock Is the Safer Buy: Annaly Capital Management or Starwood Property Trust?

Annaly Capital Management (NYSE: NLY) and Starwood Property Trust (NYSE: STWD) are two of the largest real estate investment trusts (REITs) focused on mortgage investments. Annaly is the biggest residential mortgage REIT by market cap, while Starwood is the largest one focused on commercial real estate financing. Both REITs currently offer eye-popping yields: Annaly's is 12.5%, while Starwood's is 11.6%.

Here's a look at which of these high-yielding financial stocks is the safer buy for income-focused investors right now.

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Finally trending in the right direction

Annaly Capital Management currently pays a $0.75 per-share quarterly dividend. The mortgage REIT just increased its payment from $0.70 per share. That payment boost underscores "the strong performance of Annaly's diversified housing finance portfolio and our focus on driving shareholder value," stated CEO David Finkelstein in the press release unveiling the increased payment. It's Annaly's second dividend increase in the last 18 months (it hiked its payout from $0.65 per share to $0.70 per share in early 2025). That reversed a long series of payment cuts over the years.

The REIT's improved earnings are driving the dividend increases. Its earnings available for distribution (EAD) have risen from a low of $0.64 per share in the first quarter of 2024 to its recent level of $0.76 per share. Its current earnings support its recently raised dividend.

Annaly has built a diversified platform that delivers durable cash flows and superior risk-adjusted returns. It invests in Agency MBS (pools of mortgages guaranteed by government agencies), residential credit (non-agency residential mortgages), and mortgage servicing rights (MSR). That diversification gives it the flexibility to capitalize on current market conditions. For example, it allowed its Agency MBS portfolio to decline in the first quarter while investing heavily to grow its residential credit portfolio (up 30%) and MSR portfolio. That positions it for continued EAD growth, putting its payout on a sustainable footing.

A model of income consistency

Starwood Property currently pays a quarterly dividend of $0.48 per share. It has never cut its payment in its 17 years as a public company and has maintained its current rate for more than a decade. It's the only mortgage REIT that has never cut its dividend.

That's the good news. The concern lies in its current coverage ratio. Starwood's distributable earnings were only $0.39 per share last quarter. While that was up from $0.37 per share in the prior quarter, it's still below the dividend. That's due in part to the short-term dilution from its purchase of Fundamental Income Properties for $2.2 billion last year. It took a near-term earnings hit because it wanted to own that platform. Fundamental will provide durable, growing rental income (at the time of the deal, Fundamental's portfolio of net-lease real estate had a 17-year weighted-average lease term and 2.2% average annual rent escalations). That growing rental income will be very accretive to earnings starting next year.

Fundamental Income is part of Starwood's plan to grow its earnings and dividend coverage. It has a clear line of sight to achieve earnings above the current dividend level in the coming quarters. Catalysts include growth from Fundamental Income, reinvesting higher-than-normal cash balances across its businesses, and working through the sales of real estate assets that currently aren't generating income. This visibility into improved earnings drives the REIT's confidence in the dividend.

The current numbers point to Annaly

Annaly's growing earnings have enabled the REIT to increase its dividend following a series of prior cuts. It's currently earning more than its dividend level, which should continue for the foreseeable future. Starwood, on the other hand, isn't currently earning enough to cover its dividend. While the REIT has a clear line of sight to earnings above its dividend in the coming quarters, there's always a risk its plan will fail to deliver. Given that, Annaly is currently the safer income play.

Matt DiLallo has positions in Starwood Property Trust. The Motley Fool has positions in and recommends Starwood Property Trust. The Motley Fool has a disclosure policy.