Co-authored by Treading Softly

I’ve never been able to visualize the future but have always excelled at pragmatic analysis. My wife, on the other hand, dreams of our retirement together and all we want to do. We complement each other well. She dreams, and I figure out how to make that happen financially.

Retirement planning often seems nebulous. People are often told to save a static $2 million, treating retirement as a one-time payment rather than an ongoing expense.

Most people approach retirement using the commonly recommended 4% annual deduction from their portfolio’s value. An income investor, however, can achieve this more effectively with a smaller amount of capital, allowing for reinvestment or financial flexibility using the Income Method.

Today, I present two exceptional picks to help you actively work towards that goal.

Explore Pick #1: ARI – Yield 11.9%

The mortgage REIT sector has been attracting substantial attention, and Apollo Commercial Real Estate Finance (ARI), with a yield of 11.9%, invests in floating-rate commercial mortgages.

ARI’s mortgage portfolio includes hotels, office, retail, and residential properties. Notably, its mortgages tend to be relatively short-term, with an average remaining term of 2.4 years. Moreover, 95% of the mortgages are first lien, and whenever there is a subordinated mortgage, ARI typically owns the senior mortgage as well. This European activity represents 48% of its portfolio, including 54% of its office portfolio.

Benefiting from rising interest rates, ARI’s distributable earnings have covered the dividend by 130% over the past year, exceeding the typical payout ratio for distributable earnings in this sector, which is usually around 90-100%.

In recent quarters, ARI has adopted a more defensive stance. By Q3 2023, the company had 49 loans with a carrying value of $8.0 billion, yielding 8.9%, down from 67 loans with a carrying value of $8.9 billion at the end of Q3 2022. With increasing liquidity and declining debt-to-equity ratio, ARI is poised to navigate evolving market conditions.

Despite fluctuating market expectations, ARI’s current trading at a notable discount to book value suggests investor concerns about potential book value losses as a result of increasing defaults. However, ARI’s prudent leverage and strong liquidity provide it with the flexibility to manage defaulted properties without precipitous, value-eroding sales.

We have been staunch supporters of ARI throughout 2023, and today’s 20%+ discount to book value presents an attractive opportunity for potential investors.

Discover Pick #2: NEP – Yield 13.3%

NEP, with a yield of 13.3%, offers investors another compelling opportunity in the income space. The renewable energy company has been a consistent performer, demonstrating resilience and strong potential for income-oriented investors.

The Evolution of NextEra Energy Partners: From Growth Darling to Deep Value

NextEra Energy Partners (NEP) began its journey as a value stock masquerading as a growth stock. The company capitalized on the fervor surrounding green energy, leveraging its lofty valuation to issue equity at premium prices and sustain an impressive double-digit distribution growth rate. Consequently, growth investors flocked to NEP, propelling its stock to trade at yields that appeared unsustainable. However, this situation took a drastic turn when NEP committed the cardinal sin of growth stocks: slashing forward guidance. The fallout was severe – the stock price plummeted, and the yield skyrocketed. In the space of a year, NEP’s fate transformed from that of a growth darling to one of deep value.

Since then, NEP has undertaken successful initiatives such as refinancing its due debt, albeit at higher rates, and completing the sale of its Texas natural gas pipeline to Kinder Morgan (KMI). These actions underscore the management’s adeptness in steering the company away from issuing equity at unfavorable valuations while effectively managing its debt burden.

Looking ahead, as interest rate pressures are expected to ease with a potential decrease in the near future, NEP is anticipated to navigate the period of higher-cost debt successfully.

While dividend growth expectations have been significantly curtailed, investors now have the opportunity to benefit from a double-digit yield primarily distributed as “return of capital.” This approach not only reduces one’s cost basis but also defers taxation until the point of sale. The favorable tax treatment is made possible by NEP’s substantial depreciating assets, mandated by the IRS, and the recognition of tax credits aimed at promoting the development of green energy.

The utilities sector as a whole has borne the brunt of rising interest rates. However, with the anticipated decline in interest rates, the distress is likely to subside, and investors can reap the rewards of double-digit yields from NEP while waiting for this anticipated shift.

A Glimpse of the Future

Looking at NEP and ARI, investors can relish in incredibly secure, bountiful, double-digit yields. These yields are feasible because their sector is either undervalued or misunderstood. Nonetheless, it’s important to recognize that these lofty yields are transient. As economic conditions evolve or investors gain a deeper understanding of these companies, share prices are anticipated to climb, resulting in reduced yields. At present, investors have the opportunity to benefit from double-digit yields and future capital gains.

In planning for retirement, it’s crucial to set practical goals that align with one’s overarching vision. Personally, I am the practical one, focused on developing my Income Method to make our retirement aspirations a reality, while my wife is the grand visionary, envisioning what she envisions our retirement to encompass. By diversifying one’s portfolio with high-income producing assets such as these two picks, it is possible to achieve a comparable income stream to someone with a $2 million retirement portfolio withdrawing only 4% annually. Furthermore, with less than half of their invested capital, individuals can receive the same income stream. And for those with more than half of the invested amount, there is the potential for reinvestment to further grow dividends in the future.

This is the beauty of the Income Method. This is the essence of income investing.

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