STWD - Ladder Capital Corp: 8.1% CRE Yield But It's A Hold Now (Downgrade)

2023-08-05 05:00:00 ET

Summary

• Ladder Capital Corporation's stock has shown strength but is still selling at a discount from book value.
• Ladder Capital did not originate any new loans in Q2 due to higher interest rates, but it provides a well-covered 8% dividend.
• Ladder Capital Corp owns a diversified commercial loan portfolio with limited exposure to office real estate, but the decline in loan originations may impact its net interest income potential.

Ladder Capital Corporation (LADR) has seen considerable stock price strength, with the stock running from $9.00 up to $11.50 since May, but the trust is still selling at a discount from book value.

Ladder Capital Corp did not originate any new loans in the second quarter, largely because of higher interest rates that are weighing hard on the demand for new mortgage loans. Nonetheless, the commercial REIT provides passive income investors with a well-covered 8% dividend and has room to grow its payout.

Taking into account that the origination business has completely ground to a halt and that the trust's valuation has substantially increased since my last coverage in May , I view Ladder Capital Corp as a hold for passive income investors that want to generate recurring income.

Loan Originations Drop To Zero, But Office CRE Exposure Remains Limited

Ladder Capital Corp owns a diversified commercial loan portfolio with exposure to multi-family, office and mixed-use real estate, but also invests in commercial real estate securities as well as commercial real estate equity.

Ladder Capital Corp's main investment is Senior Secured First Mortgage Loans, of which the trust owned $3.5 billion as of the end of the second quarter and they accounted for almost all of the trust's loan exposure (99%).

Unfortunately, given the headwinds for the commercial real estate sector such as falling occupancy rates and valuations , Ladder Capital Corp has originated no new loans in the second quarter. This trend in origination activity is consistent with what Blackstone Mortgage Trust Inc. (BXMT) has reported for the second quarter as well.

In 2Q-23, Ladder Capital Corp originated zero new loans in the First Mortgage and Subordinate Loan categories but received $309 million of repayments. In the long run, this decline in originations will hurt Ladder Capital Corp's net interest income potential as paid-off loans are not replaced with new income-producing loans.

Ladder Capital Corp is seeing a decline in originations due to high interest rates and other headwinds in the office market, which affects other mortgage loan originators as well. Though it does not appear that Ladder Capital Corp is making long-term strategic changes to its portfolio, the trust probably has no desire to increase its office real estate allocation given the current condition of the office market.

Since the origination business depends largely on market factors such as real estate values, interest rates, demand for new capital, etc., investors should expect headwinds to the origination business as long as interest rates stay high.

Ladder Capital Corp's entire business rises and falls with the performance of its CRE loan business. Balance sheet first mortgages accounted for the overwhelming majority of investment assets (75%) at the end of the second quarter. The remainder is invested in conduit and mezzanine loans, net-lease commercial real estate and other real estate securities.

Ladder Capital Corp Achieved 1.43x Dividend Coverage in 2Q-23

There are two reasons why passive income investors would want to own Ladder Capital Corp's 8% dividend yield, in my view:

1. Ladder Capital Corp had 1.43x dividend coverage in the second quarter and the commercial REIT has consistently covered its dividend with distributable earnings in the last year.
2. Given the amount of excess dividend coverage the trust produced throughout the last year, Ladder Capital Corp could afford to increase its dividend. While the trust did not raise its dividend in the last quarter, the high degree of excess coverage implies dividend growth potential and the present payout translates to an annualized yield of 8.1%.

Why I Continue To Recommend Ladder Capital Corp's 8.1% Yield For REIT Investors

Ladder Capital Corp as well as other commercial REITs have begun to sell at smaller discounts to book value lately and this includes Ladder Capital Corp as well as Blackstone Mortgage Trust Inc.

Starwood Property Trust Inc. (STWD) already trades at book value, reflecting growing investor confidence in the trust's multi-line investment portfolio.

Ladder Capital Corp, for instance, is presently priced at a 8% discount to book value even though the portfolio is diversified across real estate categories and the dividend does not seem to be at risk, as far as the trust's dividend metrics suggest.

Why Ladder Capital Corp's Valuation Could Experience Headwinds

Obviously, a fundamental deterioration of the economic picture in the U.S. commercial real estate market would be a big negative for Ladder Capital Corp.

The CRE segment is already seeing slowing demand for new (higher cost) First Mortgage loans and this may not change until interest rates come down substantially. Lower interest rates could restart Ladder Capital Corp's origination business and lead to new refinancings.

Though the near-term picture in the U.S. office market is challenging, I think that Ladder Capital Corp is overall well-diversified in commercial real estate.

My Conclusion

Despite First Mortgage and Subordinate Loan originations slumping to zero in the second quarter, I think there is a good reason to keep owning Ladder Capital Corp in a passive income portfolio.

The commercial REIT has good dividend coverage (1.43x in 2Q-23) and consistently out-earned its dividend with distributable income in the last year.

The trust's dividend coverage is so good that it could afford to even increase its dividend payout. Since Ladder Capital Corp's dividend coverage is still pretty good, and taking into account the sharp increase in the trust's valuation since May, a hold rating at this point seems more appropriate.

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