2023-05-03 13:06:08 ET
Summary
- Ladder Capital is seeing improved dividend coverage and distributable earnings growth.
- Though originations slowed, the trust’s portfolio is well-performing.
- Ladder Capital’s stock is now substantially undervalued.
In the last month, there has been significant valuation pressure on companies that provide capital to the commercial real estate sector.
Ladder Capital Corporation (LADR) has taken a 15% valuation hit due to concerns that higher interest rates will continue to reduce origination volumes and lower distributable earnings for commercial real estate investment trusts.
While the sector faces headwinds, I believe Ladder Capital's strong dividend coverage ratio is an important asset that passive income investors should look for in a Commercial Real Estate investment. The valuation haircut has been significant, and Ladder Capital's significant discount to book value is not justified. The 9.8% yield is an absolute steal.
Headwinds To CRE Sector Translated Into Valuation Headwinds
In March, Ladder Capital's valuation fell precipitously due to the failure of Silicon Valley Bank. The rise in interest rates, which resulted in unrealized losses on investment securities, was a major factor in the bank's failure. As a result of the bank's failure, investors have begun to be concerned about the impact of higher interest rates on the commercial real estate sector, as higher interest rates indicate a slowing in mortgage originations.
Furthermore, investors are concerned that some borrowers may fail to meet their interest obligations, resulting in a significant increase in loan defaults.
Having said that, Ladder Capital's portfolio performed well in the first quarter, and the mortgage trust's dividend coverage ratio actually improved QoQ, indicating that the trust's dividend risks have recently decreased rather than increased.
However, there has been no deterioration in credit quality: Ladder Capital recognized $25 million in loan loss allowances in 1Q-23, a $3 million increase over the average allowance for loan losses in the previous four quarters (the average quarterly allowance was $22 million).
Ladder Capital's portfolio consists primarily of high quality Senior Secured First Mortgage Loans which tend to have a low default probability.
Loan Portfolio Overview (Ladder Capital Corp)
At the end of the quarter, approximately 88% of Ladder Capital's First Mortgage Loans were tied to floating rate interest rates, implying strong distributable earnings growth potential in a rising-rate environment. In a rising-rate market, Ladder Capital has significant income upside from its existing loan portfolio.
Higher interest rates, on the other hand, have dampened demand for new investment capital. Ladder Capital's First Mortgage Loan origination volumes in 1Q-23 fell to just $15 million, down from $677 million the previous quarter.
Loans Segment Summary (Ladder Capital Corp)
Updated Dividend Coverage Metrics
Ladder Capital reported $0.38 per share in distributable earnings for the first quarter, a 12% increase YoY. The trust benefited from higher interest rates as a result of the central bank's efforts to control inflation.
Despite a drop in originations, the dividend coverage ratio in the first quarter was a very strong 165%, an improvement of 30 percentage points QoQ. In my opinion, the dividend of the real estate investment trust is thus very high.
Dividend (Author Created Table Using Trust Information)
Ladder Capital Is A Steal
Ladder Capital's stock is currently trading at $9.35, which is 15% lower than the price just before the bank crisis. Given the trust's solid dividend coverage, I believe the large discount to book value is not justified, and if LADR could rerate back to $11, investors could potentially realize 18% upside in addition to a covered 9.8% dividend.
Other mortgage trust peers like Starwood Property Trust ( STWD ) and Blackstone Mortgage Trust (BXMT) have also seen large valuation haircuts in March which I consider to be equally undeserved. Ladder Capital's valuation presently implies a book value discount of 24% compared to Starwood's 19% and Blackstone's 35% discounts.
Why Ladder Capital Could See A Lower/Higher Valuation
Through its floating rate mortgage exposure, Ladder Capital has positioned itself to profit from higher interest rates. If the Fed reverses course and lowers interest rates in 2023, Ladder Capital's net interest income upside may not be realized.
Furthermore, persistently high interest rates could dampen demand for new mortgage originations, limiting the trust's portfolio and loan growth in general.
Conclusion
I am aggressively accumulating Ladder Capital on the drop because I believe that concerns about the state of the commercial real estate market are exaggerated.
Ladder Capital's dividend coverage ratio for the first quarter demonstrated that investors have no reason to be concerned about dividend sustainability, and overall portfolio quality was solid.
The trust's stock currently has a very appealing valuation, trading at a significant discount to book value.
I believe that passive income investors can currently find good value in the commercial real estate market, and Ladder Capital is a particularly interesting and promising CRE trust to purchase due to its large discount to book value.
For further details see:
Ladder Capital: This 9.8% CRE Yield Is A Steal Again