Better Dividend Stock: AGNC Investment vs. Starwood Property Trust

Key Points

• AGNC has a very focused investment strategy to support its monster monthly dividend.

• Starwood backs its dividend with a much more diversified portfolio.

• 10 stocks we like better than AGNC Investment Corp. ›

AGNC Investment (NASDAQ: AGNC) and Starwood Property Trust (NYSE: STWD) are two of the largest real estate investment trusts (REITs) focused on investing in mortgages. AGNC is the second-largest home financing REIT with a market cap of more than $9 billion. Meanwhile, Starwood leads commercial financing REITs with its over $7 billion market cap.

Both mortgage REITs offer high-yield dividends. AGNC's yield is 14%, while Starwood's is 9.4%. Here's a look at which is the better buy for dividend investors.

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A big-time monthly dividend

AGNC Investment has a very straightforward strategy. It only invests in agency residential mortgage-backed securities (MBSes), pools of mortgages guaranteed against credit loss by government agencies such as Fannie Mae, Freddie Mac, or Ginnie Mae. AGNC invests in MBSes on a leveraged basis, primarily through repurchase agreements. Investing with leverage enables the REIT to earn much higher returns.

The REIT's investment strategy can be very lucrative. For example, in the current environment, the company can generate a return on equity in the 18% to 20% range based on how it leverages its portfolio. With its cost of capital (operating costs plus dividend payments) at or below that level, the REIT can continue paying its current monthly dividend rate. It has maintained that payout for more than five straight years.

However, while AGNC's investment strategy offers high return potential, it also brings significant risk. Leverage works both ways; while it can boost returns during healthy market conditions, it can have a negative impact during more turbulent periods. If AGNC's returns fall below its cost of capital in the future, it might need to reduce its dividend. This has happened in the past, which creates some uncertainty for income-focused investors.

Further, the REIT expands its portfolio by selling stock to buy more MBSes. For example, it issued 92.6 million shares in the second quarter, raising nearly $800 million for additional MBSes. These sales can dilute the value of its existing shares. That has been the case since its IPO in 2008, as the stock has lost nearly 50% of its value. On a positive note, AGNC's high-yield dividend has more than offset these losses (it has delivered an 11% average annual total return). However, investors must be comfortable with the possibility that the value of their investment could decline in the long term as AGNC continues to sell stock to grow its portfolio -- even if these sales do not grow the value of the stock price or dividend rate.

Diversifying to support the dividend

Starwood Property Trust has a different business model. It began by originating floating-rate mortgages backed by commercial real estate. It has since diversified to include commercial MBS investments, servicing defaulted commercial mortgages, originating non-agency residential MBSes, originating floating-rate loans for infrastructure assets, and investing directly in real estate. Today, approximately 56% of its portfolio consists of commercial loans, 13% are properties it owns, and the remainder comprises a mix of infrastructure lending, residential lending, and other assets.

The REIT's increasing diversification provides many benefits. For example, while AGNC invests in fixed-rate mortgages, Starwood primarily invests in floating-rate mortgages. As a result, changes in interest rates have less of an impact on Starwood's business. If interest rates rise, the interest earned on the floating rate debt it holds increases. Starwood also benefits from rising rental income from its owned properties and the potential to benefit from an increase in the value of that real estate. The REIT recently significantly boosted its owned real estate portfolio by acquiring Fundamental Income in a $2.2 billion deal, adding a portfolio of properties that produce stable, reliable, and growing cash flow.

Starwood has built a more durable and lower-risk portfolio, which has enabled the REIT to maintain its current dividend rate for more than a decade. Meanwhile, its equity investments in real estate assets that can appreciate in value have helped nudge up its stock price over the years. It's up more than 25% from the IPO price. That growth, when combined with its lucrative dividend income, has resulted in a substantial total return of 10.4% annualized.

A better bet

AGNC's straightforward investment strategy has enabled it to pay a generous monthly dividend. However, it's a higher-risk, higher-reward strategy. On the other hand, Starwood's diverse portfolio offers a more balanced risk profile, supporting dividend stability across varying market cycles.

That lower risk profile makes Starwood the better dividend stock between the two. It's more likely to maintain its dividend if market conditions deteriorate. It also offers the potential for value appreciation from its expanding portfolio of owned real estate. Those factors could enable Starwood to produce higher total returns compared to AGNC in the coming years.

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.