ACR - ACRES Commercial: Preferreds For Yield Common For Upside

2023-06-12 18:00:06 ET

Summary

• ACRES Commercial Realty Corp. is a mortgage REIT valued at $75 million, offering potential for income and total return investors.
• Since ACRES Capital took over management 2.5 years ago, the company's book value per share has increased by around 40%.
• Despite past declines in book value, current management has stopped and reversed the trend, though there is no guarantee of continued growth.

Note: This article was released on Cash Flow Club on June 6.

Article Thesis

ACRES Commercial Realty Corp. ( ACR ) is a smaller mortgage REIT that is valued at just below $70 million. While not very well known, the company could be interesting for income investors -- with its preferred shares ACR.PC and ACR.PD ( ACR.PC )( ACR.PD ) -- and for total return investors, as the common trades significantly below book and offers a substantial AFFO yield. There are some potential risks and issues investors should keep in mind, however.

Company Overview

ACRES Commercial Realty Corp. is a mortgage real estate investment trust (or mREIT) that was incorporated a little less than 20 years ago and that was named Exantas Capital Corp. in the past. ACRES Commercial Realty Corp. is externally managed by ACRES Capital, LLC, a subsidiary of ACRES Capital Corp., which is a private CRE lender. While external management isn't necessarily good for investors, as external managers can be incentivized to prioritize "empire building" over value creation, ACRES Commercial Realty has performed relatively well since ACRES took over around 2.5 years ago. Since then, book value per share rose by around 40%, although most of that happened in a short period of time as the company recovered from the pandemic, while book value has been more or less flat in recent quarters. Still, that's a lot better compared to the track record before ACRES took over, as we can see in the following chart:

Under previous management, ACRES Commercial Realty has seen its book value drop massively on a per-share basis, which explains the weak total return investors have seen since the company's IPO. Today, shares trade for $8.40 -- down way more than 90% from the first trading day. I believe this shows pretty well that external managers can be pretty bad for shareholders, although current management (ACRES Capital) is doing a better job, having stopped and even reverted the trend of declining per-share book value. That is, of course, no guarantee that book value will continue to grow in the future, too, but I believe that the chance for that is a lot higher under current management compared to past management.

ACRES Commercial Realty primarily owns multifamily loans. Commercial real estate has recently been in the news due to struggles for some properties, but those are mainly related to office properties. Even more precisely, lower-grade office properties and those properties that are located in cities with a negative net migration seem to struggle, while other office properties are performing better. Some malls, especially those located outside of densely populated areas, are struggling as well, but that has been true for a couple of years already.

People will always need a place to live, no matter the strength of the economy. This makes multifamily and other forms of residential real estate less cyclical and less risky compared to more cyclical types of properties, such as retail real estate, office properties, or hotels. High interest rates have made homes less affordable over the last year, which could be positive for multifamily real estate owners -- after all, if fewer families can purchase their own homes, demand for properties that can be rented should increase, all else equal. With ACRES Commercial Realty having 76% -- the vast majority -- of its loans allocated to multifamily real estate, the company's loan portfolio looks less risky compared to many other mortgage REITs that have higher exposure to at-risk property types such as office or retail.

Recent Results

ACRES Commercial Realty Corp. announced its most recent quarterly results in May. The company grossed revenues of $21 million, which was up by more than 90% compared to the previous year's quarter. This easily beat expectations, as analysts were looking for a smaller revenue gain. Looking into the details, we see that the driving force for higher revenues was higher net interest income. While ACRES experienced higher interest expenses, which rose by $16.5 million year over year, the growth experienced in its interest income was even more pronounced, as ACRES' interest income rose by close to $23 million year over year. On a net basis, this almost doubled ACRES' net interest income, from $7.8 million to $14.0 million.

Real estate income was up handsomely as well, although from a smaller base, which is why the revenue growth contribution was less pronounced on an absolute basis.

ACRES Commercial Realty's President & CEO Mark Fogel stated the following during the earnings call [emphasis by author]: "As always, we are dedicated to pursuing opportunities for growth while maintaining our consistent focus on preserving shareholder value."

When it comes to pursuing growth, ACRES has indeed executed very well, showcased by the strong revenue increase over the last year. ACRES Commercial Realty is not making any dividend payments for now (on its common shares), which means that profits and cash flow can be reinvested into its business, which helps explain why ACRES has shown better business growth compared to many other mortgage REITs, where common stock dividend payments eat up a significant portion of the company's cash flows and earnings.

On a GAAP basis, ACRES Commercial Realty generated a net loss during the most recent quarter, at $0.28 per share. That's not too reflective of the cash flows the company generated over the same time frame, however. Several non-cash items impacted the company's GAAP profit, such as higher provisions for potential credit losses, and depreciation in its real estate portfolio. Earnings available for distribution, which is a non-GAAP metric that is closer to cash flow and that is used by some companies, have been easily positive, at $0.52 per share. Annualized, that's more than $2, which makes for a pretty low valuation, considering ACRES Commercial Realty is valued at a little less than $10 per share. The company's earnings available for distribution yield of more than 20% is attractive.

Common For Potential Upside, Preferreds For Income

With no dividend payments on the common shares, ACRES Commercial Realty is a somewhat unique mortgage REIT -- many mortgage REITs are income investments primarily.

Investors that choose to buy the common get no income, at least for now, but they might experience considerable share price upside in the long run. The book value per share stood at $24.51 at the end of the first quarter, which means that shares are trading at around 0.34x book value today. Due to the weak track record of the company, it's not surprising that the valuation is low, but I believe that it is important to note that the track record has improved meaningfully once ACRES took over around 2.5 years ago. When the current management team continues to execute well, the valuation could expand. With appealing underlying business growth and with shareholder-friendly moves such as buybacks below book value (something ACRES has been doing), book value could continue to climb in the long run. Add upside potential for the book value multiple, and ACRES Commercial Realty could experience meaningful share price appreciation.

That being said, due to the small size of the company and uncertainties in the CRE space, I do not believe that upside is locked in or certain. Investors should also consider the fact that shares aren't very liquid before making an investment.

For those investors that want an income holding, ACRES Commercial Realty's preferred shares could be worthy of a closer look. ACR.PC, a cumulative preferred share, is trading with a dividend yield of 10.5% today (June 12), while ACR.PD, another cumulative preferred share, trades with a marginally lower yield of 10.3%.

Due to being higher in the capital stack, these preferreds are less risky than the common (which isn't looking ultra-risky, either). The upside potential for these preferreds is more limited relative to what could happen for ACRES' common shares in a bullish scenario, as they trade at around 80% of par, but their income potential is pretty strong.

Takeaway

ACRES Commercial Realty isn't a large mortgage REIT, but it could be worthy of a closer look. The valuation on the common is pretty low and current management has executed well, especially relative to the previous manager. If that continues, both the company's book value and its valuation could expand, which may result in substantial share price gains. CRE exposure is something many investors want to avoid in the current environment, but ACRES is focused on a less risky segment, multifamily, which reduces risks relative to mREITs with a focus on office property loans, for example.

For income investors, ACRES Commercial Realty's common isn't interesting, as management is focused on business growth and buybacks while not paying any dividends, but the preferreds could be an option with their attractive yields of 10%+. Keep in mind that this is a smallish company and that trading isn't very liquid in case you are considering an investment.

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