This Real Estate Stock Is Yielding 14.6%!

DX +0.57%

Key Points

• Real estate investment trusts (REITs) are known for paying strong dividend yields, largely due to their unique corporate structure.

• But investors should be wary of ultra-high dividend yields like this.

• 10 stocks we like better than Dynex Capital ›

When evaluating dividend yields, I generally consider a sustainable 3% yield to be very solid. When I recently saw Dynex Capital's (NYSE: DX) massive 14.6% trailing 12-month dividend yield, I was skeptical, to put it mildly.

However, the company has been making consistent monthly dividend payments dating all the way back to 2008, although the dividend has fluctuated a bit. Still, with a yield as high as this, a little fluctuation is OK as long as the company consistently makes dividend payments.

Dynex is a real estate investment trust (REIT), which means it can avoid paying corporate taxes as long as it distributes at least 90% of its taxable income in the form of dividends to shareholders, among other requirements related to its real estate activities. But investors should be wary of dividend yields that seem too good to be true.

The dividend may be at risk

Dynex Capital is a mortgage REIT and invests heavily in residential mortgage-backed securities. This can lead to extreme fluctuation in the company's earnings, which can also be heavily impacted by the movement of interest rates.

While Dynex has a good track record, its payout ratio is high, and its trailing 12-month free-cash-flow yield is now significantly lower than the company's dividend yield. These are often significant red flags when evaluating dividend stocks.

Now, this doesn't mean the company will ever outright eliminate its dividend. And if the company could offer a dividend yield of 10% or 12% over the long term, that would still be incredibly strong. However, Dynex is difficult to evaluate because management employs a highly complex hedging strategy, using a significant amount of derivatives, including interest rate swaps and futures, to manage the balance sheet through different interest rate environments.

Ultimately, I think investors can take a shot on the stock for passive income, but I wouldn't suggest making it one of your top dividend holdings.

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Bram Berkowitz 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.

This Real Estate Stock Is Yielding 14.6%! was originally published by The Motley Fool