BRSP - 4 High Yielding REITs We're Buying Amid SVB Meltdown

2023-03-13 07:00:00 ET

Summary

• For most banks and commercial mortgage REITs, higher interest rates are good news because they get paid more interest on their loans.
• This was not the case for SVB because so many of its assets were tied up in long-duration bonds, which saw their market value fall as rates went up.
• Although the latest SVB news casts an ugly light on the banking sector, we believe that these four mREITs are positioned to weather the storms.

In a blog last week, I explained that Friday “ seemed like Groundhog Day, at least in the banking sector.” I went on to explain that “although I live on the East Coast, this West Coast bank closure hits home .”

That’s because I “ recently joined the advisory board for an AI startup known as nRoads, an intelligence solutions provider that uses AI to solve specific business and data problems.

Like many other tech startups, nRoads opened a deposit account with Silicon Valley Bank because of its reputation for providing favorable terms for technology and venture-backed investments .”

However, “ thankfully, nRoads will be just fine as its funds are insured by the FDIC. But others aren’t so lucky .” Rachel Posner, Chief Client Officer and Managing Director at Kroll explains,

“There may be some contagion to other small, community banks in the U.S.—particularly if depositors aren’t all made whole--but the larger banks are unlikely to follow in SVB’s footsteps. SVB is yet another example that we can expect market disruptions as central banks raise rates and shrink their balance sheets.

Posner doesn’t believe that SVB is a harbinger of things to come across the U.S. and global banking system because the bank “was unusually exposed to interest rate risk, partly because its clients only thrived in a low interest rate world and cash funding for them evaporated as rates rose.”

For most banks and commercial mortgage REITs, higher interest rates are good news because they get paid more interest on their loans. This was not the case for SVB because so many of its assets were tied up in long-duration bonds, which saw their market value fall as rates went up.

As seen below, the commercial mREITs in our coverage spectrum dropped by an average of 4% on Friday, as small cap builder finance REIT Sachem Capital ( SACH ) fell the hardest – around 7% in one day of trading.

The commercial mortgage REITs have fallen by an average 0f -.60% YTD, however, without Broadmark Realty ( BRMK ) – up 32% YTD due to the announced acquisition by Ready Capital ( RC ) – the sector would be down by around -3% YTD.

( See latest article on Ready Capital HERE )

Investors seeking high yield are now fixated on this unique sector that has a favorable opportunity set given higher rates that these REITs are generating in this Fed-induced rate cycle. As seen above the average dividend yield for the group is 12%.

As mentioned, Broadmark Realty is up 32% year-to-date, but still in the red bigly thanks in large part to the shaky earnings history: EPS was $.75 /sh in 2020, $.71 /sh in 2021, $.52 /sh in 2022, and consensus for 2023 is just $.38 /sh.

One of the best ways to screen for opportunistic mREITs is to examine the payout ratio using the current dividend per share and 2023 analyst EPS estimates. Not a bullet proof way to analyze dividend safety, but certainly a good indicator of dividend strength.

As you can see (above) there are four REITs that we consider worthy of buying and the average dividend yield (for these 4) is 10.7%. Much more, they’re trading at a discount and our total return forecast is an average of 20% annually.

That’s precisely why I prefer high quality mREITs versus preferreds…I get two bites at the apple (so to speak) – safe high yield and the potential for string price appreciation. Let’s take a closer look at the fab four…

( We just wrote on 3 preferred picks at iREIT on Alpha )

Starwood Property Trust: 9.8% Dividend Yield

Starwood Property Trust ( STWD ) is a commercial mREIT externally managed by SPT Management. The external manager is run by Barry Sternlicht who also serves as Starwood’s Chairman and CEO. STWD specializes in originating, acquiring, and managing mortgage loans. They operate in the U.S., Europe, and Australia and categorize their operations into the following segments:

As you can see above, the vast majority of Starwood Property Trust’s loans were first mortgage commercial loans, making up 64% of the loans held for investment. Their infrastructure loans made up 9% and their residential loans made up 10% of their loans held for investment. They also have loans held for sale with residential loans making up the majority of this category.

In 2022 STWD completed $10.7 billion of investments across businesses with initial fundings of $9.3 billion and follow-on fundings of $1.1 billion. The REIT had repayments and sales of $3.7 billion, including $1.9 billion from commercial lending, securitization proceeds of $3 billion and newly issued corporate debt of $1.1 billion.

STWD has significant liquidity with $1.1 billion of cash, $250 million of which will be used to repay convertible notes maturing on April 1. The company also benefits from excess unencumbered assets and gains within the property portfolio, both of which can be utilized to create additional liquidity.

STWD has only 13% in office exposure which is one of the lowest levels in the peer group (and almost no exposure to New York or San Francisco). The company has a few unproductive assets on the books - buildings in Houston and in Los Angeles – that are not contributing anything.

While we regret the fact that STWD has not been much of a dividend grower, we feel good about the safety of the dividend. As seen below, EPS is forecasted (by analysts) to be $1.92 in 2023, which easily covers the $2.12 /share dividend. As viewed below, we’ve modeled STWD to generate annual returns of 15% over the next 12 months:

Blackstone Mortgage: 12.3% Dividend Yield

Blackstone Mortgage ( BXMT ) is an externally managed commercial mREIT that originates senior loans that are collateralized by commercial real estate. Most of the collateral is secured by first mortgages and is located in the U.S. Europe and Australia.

BXMT has a $26.8 billion loan portfolio consisting of 203 loans that is 100% floating rate which enables them to maintain margins under rising rates. With the current interest rate environment, Blackstone Mortgage should continue to benefit from this loan structure.

The loans they originate have conservative exposure with a weighted average origination loan-to-value (“LTV”) of 64%. Their collateral is diversified by property type with office properties being the largest category at 40%. Multifamily is the next largest at 24%, followed by hospitality properties at 18%. BXMT is managed by Blackstone ( BX ), which is the largest private equity real estate business in the world.

As you can see above. BXMT has 40% exposure to office and in Q4-22 the company had four loans with new specific reserves that date back to before COVID (2017 on average). The company said that three of these loans are backed by office properties that are “bearing the brunt of the post-COVID realignment in demand, most notably a significant reduction in government tenant office utilization”.

On average BXMT’s reserves are 20% of its loan balance and imply asset value reductions of nearly 50%. Overall, around 54% of BXMT’s office loans are backed by assets that are newly built or recently substantially renovated, with an average vintage of 2021 and an average origination LTV of 60%.

And around 34% of the office portfolio, most of the remainder, carries one or more significant credit enhancing qualities, such as low leverage, high debt yield, location in high growth Sunbelt markets or material additional sponsor equity commitment in the last year. BXMT’s overall loan portfolio is 97% performing and in 2022 the REIT collected $3.7 billion of repayments, nearly 50% of which were on office loans.

BXMT’s five-rated loans with specific reserves represent only 3% of the gross loan portfolio, 10% of the loans have a risk-rating of four, all of which are performing and current. The remaining 87% of the portfolio is rated three or better.

In 2022 BXMT added $3.6 billion of new credit facility capacity with its key banking relationships and liabilities are term matched to assets with no material corporate debt maturities until 2026. BXMT’s liquidity was $1.8 billion as of 12/31.

BXMT generates $.62 per share in quarterly dividends and the dividend is amply covered. As management pointed out on the latest earnings call, “in an onerous downside scenario, where all of our five-rated loans and all of our four-rated office loans stopped paying interest, our 4Q earnings level would still cover our dividend with a healthy cushion, all else equal.”

BXMT is now yielding a juicy 12.1% and we model shares to return 25% annually.

BrightSpire Capital: 12% Dividend Yield

BrightSpire Capital ( BRSP ) is a commercial mREIT focused on originating, acquiring, financing and managing a diversified portfolio of commercial real estate debt and net lease real estate investments.

As of Q4-22 the company had $4.2 billion of assets, mostly senior loans ($3.5 billion) and net lease assets ($722 million). As see below, the loan portfolio if primarily invested in multifamily (40%) and office (39%):

As of Q4-22 BRSP had a modification to a $116 million office loan, the largest office loan in the portfolio, that included the sale of one of the four underlying office properties coupled with an equity contribution from the borrower reducing exposure to this loan by $29 million. The current balance of the loan (post modification) was reduced to $87 million.

With interest rates trending higher BRSP “anticipates more loan extensions and modifications within the portfolio”. The average loan size for the loan portfolio is $34 million and the risk rating is 3.2. There are 32 office loans with an average loan balance of $37 million.

As of Q4-22 BRSP had liquidity of $284 million in unrestricted cash and $449 million of total liquidity. As referenced in a recent article , last week BrightSpire said that they were pricing a secondary offering to unload DigitalBridge’s ( DBRG ) stake (in BRSP) at $6.00 per share. Shares are down over 10% in the last 5 days.

BRSP’s dividend is well-covered and we’re modeling shares to return 20^% over the next 12 months (current dividend yield is 12%).

Ladder Capital: 8.5% Dividend Yield

Ladder Capital ( LADR ) is an internally managed mREIT that specializes in commercial real estate finance. They originate loans and have a portfolio of diversified investments in commercial real estate and assets related to real estate with a focus on senior secured assets.

Mortgage loans makes up the majority of LADR’s business with 64% of total assets in this category. Their net lease properties makes up 8% and their diversified real estate is 3% of their total assets, while investment grade securities makes up 10% of their total assets. As viewed below, their loan portfolio consists of multiple property types with the largest being multifamily, office, and mixed use.

As seen above, LADR has 25% in office exposure with:

LADR has maintained stable performance within the office loan portfolio, which comprises 25% of the REIT’s total loan portfolio. If you exclude LADR’s two largest office loans, that percentage drops to just 18% with a $25 million average loan size.

LADR’s top five office investments by size across the loan and equity portfolios had a combined carrying value of approximately $640 million. There were two equity investments that combined for a total carrying value of $242 million, both were financed years ago with non-recourse fixed rate CMBS debt that still have time before maturity.

The other three office investments are first mortgage bridge loans and the combined loan amounts is $397 million. The largest loan is a $220 million loan secured by a downtown Miami office building that was acquired in mid-2021 by LADR’s borrower. This asset is over 65% leased with an average lease term of about 6 years. The sponsor invested $98 million of equity when the property was acquired.

LADR has one of the strongest balance sheets in the peer group, the company ended 2022 with $609 million in cash and undrawn $324 million revolver and an adjusted debt-to-equity ratio below 2x. The payout ratio is one of the best in the sector at 74%.

As viewed below, LADR has solid upside based on the potential for future dividend increases supported by solid earnings power as the company makes new investments in market conditions exhibiting the highest mortgage interest rates in many years. We model 20% annual returns over 12 months.

In Closing…

iREIT has carefully screened for the safest mREITs that offer the best of both worlds – safe high yield and attractive total return prospects. Although the latest Silicon Valley Bank casts an ugly light on the banking sector, we believe that these four mREITs are positioned to weather the storms.

The key risks to all four are within the office sector, and I like what Starwood’s chairman, Barry Sternlicht, had to say on the company’s recent earnings call,

“I personally like being in the office. I don’t like working from home, but most of the younger generation actually likes working from Jackson Hole and Montauk. So, I think that’s going to change in a recession.

It has been easier for people to fire people that are not in their offices. You obviously don’t see them. You’re not attached to them, and they aren’t exactly raising the banner for the company and making it a great place to work. So, I do think that will change.”

Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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