2023-09-28 07:00:00 ET
Summary
- We recommend owning commercial mREITs for high dividends and potential price appreciation.
- Ladder Capital is highlighted as a top COVID pick with a strong business model and attractive returns.
- LADR's portfolio consists of a diversified mix of assets, including first mortgage loans, investment-grade securities, and net lease properties.
A few days ago, I wrote a Who Wants To Be An Office Lender? highlighting a few of my favorite commercial mREITs.
As I consistently remind readers, I like owning commercial mREITs because I get the best of both worlds: high dividends and price appreciation.
Now, to be clear, price appreciation is not guaranteed.
And neither are high dividends.
And that’s why I maintain a healthy mix of mREITs and preferreds.
I’ve been adding more of both to my REIT portfolio that now looks something like this:
Brad Thomas
I like this blueprint because it provides me with enhanced yield (preferreds and mREITs) as well as attractive total return attributes.
I was fortunate to get greedy during COVID-19 and increase my exposure within the commercial mREIT sector.
Of course, these returns were generated during unprecedented times, and the likelihood of a repeat is slim to none.
As you can see (above), Ladder Capital ( LADR ) was one of my top COVID picks which means that our team had to dig deep into the business model in order to gain confidence in our Strong Buy recommendation.
As you can see, LADR is now trading at $10.58 (per share) and shares have returned 12.3% year to date:
Let’s dig deeper into this interesting commercial mREIT so you can see firsthand why I’m buying more shares hand over fist.
The Basics
In case you’re not familiar with mREITs, a few excerpts from our overview:
“While the intricacies appear complex, mREITs essentially provide financing to buy real estate similar to how a traditional bank or credit union originates mortgage loans so an individual can purchase a house. The amount of debt and equity involved, otherwise known as leverage, depends on the credit worthiness of the borrow and the asset itself.”
Within the commercial mREIT sector, you can break down the REITs into two categories:
Pure Balance Sheet Lender : They originate or purchase loans for their own balance sheet and hold these on their balance sheet. Examples include Blackstone Mortgage ( BXMT ) and Apollo Commercial ( ARI ).
Balance Sheet / Conduit Lender : They originate and/or purchase loans for their own account (balance sheet) or to be sold into a securitized vehicle such as CMBS (conduit). Examples include Starwood Property ( STWD ) and Ladder Capital.
While senior secured lending is Ladder’s core business, the REIT is diversified as shown below:
LADR - IR
As you can see, more than 50% of LADR’s assets are unencumbered and 84% of these unencumbered assets are comprised of first mortgage loans, investment-grade securities, and cash and cash equivalents.
LADR maintains a considerable surplus of unencumbered assets over the amount required by its covenants, currently totaling over $1 billion. This cushion provides the company with a great deal of flexibility and enhances its liquidity profile.
The balance sheet portfolio totals $3.5 billion with a weighted average coupon of 9.15%.
Breaking down the loan portfolio, LADR focuses on middle market borrowers with an average loan size of $25 million (largest loan in the portfolio is $221 million). Compare that with these peers:
Average Loan Size
- Ladder Capital: $25 million
- Blackstone Mortgage: $120 million
- Starwood Property: $125 million
- KKR Real Estate ( KREF ): $126 million
This means that LADR takes a nimbler approach and is less exposed to large loans that could result in concentration risks. Since inception in 2008, Ladder has originated $45 billion of loans in more than 475 cities across 48 states.
LADR - IR
As you can see, Ladder is not a construction lender and has modest funding of just $272 million (as of Q2-23). Importantly, the company’s loan portfolio is 99% senior secured (first mortgage loans) with an average LTV (loan to value) of 67%. Compare that with these peers:
- Ladder Capital: 67%
- Blackstone Mortgage: 64%
- Starwood Property: 61%
- KKR Real Estate: 65%
As you can see above, LADR’s loan portfolio is comprised of:
- Multifamily: 22% of assets ($1.242 million)
- Office: 16% of assets ($916 million)
- Mixed Use: 12% of assets ($677 million)
- Other: 12% of assets ($693 million)
While LADR is exposed to the office sector, 75% of these loans were originated post-COVID.
In addition, two of the office loans (Miami and Aventura) account for 36% of the office exposure. These two larger loans ($221 million and $110 million) have 30% borrower equity (around $138 million in total) with excellent performance.
LADR did add a new loan to nonaccrual in Q2-23, a $35 million loan on a mixed-use asset in which LADR is pursuing foreclosure. The borrower’s basis is $55 million which is comprised of 174 newly constructed multifamily units and three floors of office and commercial space in Pittsburgh.
As mentioned previously, LADR owns around $900 million of “brick and mortar” real estate that consists of net lease properties (72% of real estate owned) and others (28%).
The net lease portfolio consists of 156 properties leased to high-quality tenants (69% investment grade) like BJs, Walgreens, and Dollar General. The portfolio’s gross asset value is around $663 million with a weighted average remaining lease term of nine years.
The net lease portfolio generates $41.7 million of NOI and the other properties generate around $18.8 million annually.
LADR’s CMBS business is mostly confined to five-year loans, the carrying value of the securities portfolio is around $458 million, comprised of 82% AAA-rated and 99% investment-grade rated securities.
In Q2 LADR received $75 million of paydowns. In Q2 LADR began to take advantage of opportunities to add to its securities portfolio by acquiring additional AAA CLO securities that are currently offering highly attractive returns.
The Balance Sheet
As of Q2-23 LADR had $1.1 billion of liquidity with a leverage ratio of 1.7x. This liquidity was comprised of $777 million plus undrawn revolver capacity of $324 million (with a maturity in 2027).
Unsecured bonds anchor the capital stack with $1.6 billion outstanding, or 40% of debt with a weighted maturity of 4.3 years with an attractive fixed rate cost of capital of 4.7% average coupon.
LADR has a strong financial condition with a corporate credit rating one notch from investment grade (two of three rating agencies). LADR has a $50 million share buyback authorization in place with $44 million of remaining capacity (no purchases in Q2-23).
One key differentiator for LADR is its modest total leverage with a highly durable composition of financing alternatives.
LADR emphasizes on unsecured and non-recourse, non-mark-to-market financing with a substantial unencumbered asset base (as shown below).
84% of unencumbered assets are cash, first mortgage loans, or investment grade securities:
Internal Management
Another differentiator for LADR is management.
The company is one of the few internally managed mREITs in which management and directors own >10% of the company (>$150 million equity investment). Also, employees are compensated based on profits and with a significant portion in stock.
The executive management team averages 27 years of industry experience and the majority of the management team has worked together for >25 years.
As seen below, this deep bench of seasoned professionals – managers average 11 years at Ladder and 23 years of industry experience.
The Perfect Storm
As seen below, LADR trades at $10.58 per share with a P/E multiple of 8.1x – around 50% below the normal P/E.
The dividend yield is 8.7%, lower than most of the peers that average around 11%.
FAST Graphs
Like many mREITs, LADR’s earnings history is choppy.
Unlike traditional equity REITs, mREITs like LADR generate revenue from loans which makes the earnings stream less predictable.
As you can see below, the company generated EPS of $2.03 in 2018 and fell to $.49 in 2021. In 2022 the company generated EPS of $1.16 and analysts forecast $1.37 in 2023.
LADR was forced to reduce its dividend in 2020 which resulted in a dividend payout of $.80 in 2021.
Last year LADR paid out $.88 per share and currently the company is paying out $.23 per share ($.92 per share annualized).
Analysts are forecasting EPS of $1.37 in 2023, which means there’s a cushion in which the company could payout a special dividend this year (which it has in previous years).
Using the analyst numbers, LADR’s payout ratio in 2023 is around 67%.
As one analyst pointed out on the Q2-23 earnings call, LADR has “significantly over-earned it (dividend) year-to-date” which means that there’s a good chance that LADR will boost the dividend (and perhaps gift a special dividend in December).
Let’s compare a few peers:
iREIT®
Now let’s compare LADR’s P/E with the peers:
iREIT®
Interesting…
LADR has the lowest payout ratio and one of the best balance sheets in the sector and yet shares are trading at a discount (to the peers).
Now let’s take a look at analyst estimates for 2024 and 2025.
EPS Analyst Growth Estimates
iREIT®
While LADR may be the lowest-paying mREIT on our shopping list, we believe the total return prospects are compelling. The dividend is well protected, and I like the fact that LADR owns real estate (mostly net lease real estate).
I believe shares are worth more than $10.58 and they could fetch as much as $12.00.
Given the fact that commercial banks are slowing down dramatically (which faces more pressure on small developers with lingering debt maturities), LADR is well positioned to capitalize on new demand.
Some of the demand will be in the form of traditional senior secured lending, and some will be in the form of growing mezzanine loans. As CEO, Brian Harris, said, “This is a market that is ripe for mezzanine lending, obviously, in special situations.”
I like this line of thinking.
Traditionally mezz loans are riskier, but Harris is looking to provide an A/B component which means splitting up the senior secured (in a 10-year fixed rate instrument) and the mezz loan (on LADR’s books).
Given the fact that LADR’s wheelhouse is “middle market” customers (average $25 million loan size), this could create a lot of demand.
Of course, LADR has plenty of powder right now – around $900 million – and I suspect the company will begin to put that to good use sooner than later.
We believe LADR could return over 20% annually, which ain't bad given the fact that the yield is currently 8.7% with a likely boost coming soon.
If I were a regional developer (like I once was) and I knew my shopping center loan was coming due (and my bank would not renew it), I would be knocking on LADR's door.
Remember folks, the game is all about supply and demand.
And managing risk is what separates the best from the rest.
I like my odds with Ladder!
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.
For further details see:
Ladder Capital: The Perfect Storm