In case you missed, I have been writing a series called "Thirsty For Yield," in which I have provided research on a number of higher-yielding REIT securities. None of the REITs that have been recommended in the series have been "sleep well at night" companies. In fact, all of them are less stable than the traditional Equity REITs that I normally endorse.
Don't worry. The purpose for the Thirsty For Yield series was not to "rock the boat" and bring more risk to your daily living routine. To the contrary, my objective is to provide more alternatives for income since we are all living in this yield-starved environment.
Our goal is to expose investors to various forms of the REIT pie ranging from equity, to debt, and to preferred shares. Recently, we wrote on REIT bonds here and here, and we also recommended our favorite mREIT preferred series here.
One sector that is often over-looked is the Commercial Mortgage REIT sector.
We view this sector as an important REIT class that offers attractive supply and demand fundamentals along with a sound risk-adjusted return profile. Unlike residential mortgage REITs, commercial mREITs lend money on floating rates, so as rates rise, they make more return.
Commercial mortgages have much less interest rate risk. The key risk is typically credit risk, so the competence of the underwriting team is very important. I wrote an article comparing residential and commercial mREITs here.
Three of my Thirsty For Yield picks have been Apollo Commercial (NYSE:ARI), Starwood Property Trust (NYSE:STWD), and Blackstone Mortgage Trust (NYSE:BXMT) - all unique in their own right with varying risk/return attributes. In my final article (of the series), I decided to save the best for last…
A Different REIT, Perhaps Misunderstood
In 2014, Ladder Capital (NYSE:LADR) commenced the necessary steps to convert from a C-Corp into a REIT structure, and during the first quarter of 2015, the company received shareholder approval to convert to a REIT. We commenced coverage on LADR in May 2015, and since that time, shares have declined by over 30%.
More importantly, since our initial recommendation, LADR's dividend yield has increased by over 58%.
Although LADR is relatively new to the REIT scene, the senior management team averages 27 years of industry experience and insiders (management and directors) own around 11.9% of the company (the CEO owns around 5%).
As noted above, and to be clear, there are several different types of mREITs. Some are commercial mREITs like LADR that provide financing for commercial real estate; others fund the residential mortgage market.
Across all these types, we prefer to own the commercial mREITs that tend to be conservatively managed. There is little appetite for credit risk these days, but more importantly, there are good investment opportunities with moderate levels of risk and we consider LADR one such alternative.
As a commercial mortgage REIT, LADR invests in commercial real estate debt and equity, a sector we know well and that has moderate new supply constraints, new completions are well below US aggregate construction levels.
This strong commercial real estate environment marked by healthy property transaction volume gives rise to strong borrower demand for transitional capital. As evidenced by the chart below, commercial property sales volumes are continuing to grow:
Also, the backdrop is favorable as there is strong demand for senior commercial real estate as evidenced by the increased volume of CMBS issuance:
Unlike Blackstone Mortgage Trust (NYSE: BXMT) and Apollo Commercial Real Estate Finance (NYSE: ARI) - that both originate purchase loans for their own balance sheet, a pure balance sheet (although they may sell participation units in the loans to diversify some of the risks) - LADR (and STWD) is a balance sheet/conduit lender that originates and/or purchases loans for its own account (balance sheet) or to be sold into securitized vehicles such as CMBS (conduit).
As you can see below, the CRE mortgage maturity pipeline offers a healthy market backdrop for LADR to originate new deals.
Due to increasing regulation for commercial banks, LADR is well-positioned to capitalize on the growing demand in CRE lending.
Ladder Capital's Triangular Approach to Profitability
Part of the under-performance with LADR has to do with the lack of coverage and complexity risk. While some analysts and investors may get confused with the business model, I find it simple.
LADR set up the company in a "triangle" fashion to provide a flexible and simple lending model with diversified earnings drivers - all from complementary business lines. Here's a snapshot of the 5 lines of business:
LADR's tactical approach to the mREIT sector is rooted in the flexible manner in which the company can interact in periods of change. As the triangle below illustrates, LADR can capitalize on its 3 primary lines of business in order to take advantage of the most profitable trends.
LADR's Senior Secured Balance Sheet business represents around 43% of revenue (in Q1-16) and this business is similar to BXMT and STWD. Generally, LADR's loans are for 2-to-5-year terms. LADR's conduit finance business represents around 9% of revenue and this business line is comparable to STWD's subsidiary called LNR. In Q1-16, LADR's conduit business was volatile, and therefore, the margins for this line of business were weaker.
Conduit loans are typically 5 to 10 years offered at fixed rate with LTVs (loan to value) of around 70% to 75%. Here's an example of how LADR's securitization model works:
As you can see, LADR is able to recycle its capital multiple times increasing the earnings power. As evidenced by the snapshot above, LADR has slowed its securitizations in Q1-16 and 38 out of 39 securitizations have been profitable. Also, as you can see below, LADR's loan portfolio decreased in Q1-16 due to a few larger repayments (in Q1-16).
As of Q1-16, the loan portfolio totaled $1.9 billion with an average loan balance of $16 million. Around 64% of the loans are floating rate and 36% fixed rate. The weighted average last dollar LTV is 66%. Here's an overview of the loan products:
Here's a snapshot of the loan portfolio:
As part of the "triangular" approach, LADR takes advantage of market disruptions - when it's hard to lend, LADR invests in CMBS. As the time line illustrates below, LADR has been able to capitalize on favorable conditions when financial markets are disruptive.
The final leg to the stool (or triangle) is LADR's Equity platform - representing around 24% of revenue (in Q1-16). As you can see below, LADR has acquired ~6.8 million square feet consisting of around $902 million of assets (book value).
The company owns a number of net leased properties leased to Walgreens and Hy-Vee Supermarket. By owning these hard assets, LADR essentially gets "2-bites-at-the-apple" by collecting rent checks and also creating in-house CMBS loans. Also, the owned assets provide a depreciation shield (around $8 million per quarter).
To demonstrate LADR's opportunistic approach, the company provided the following case study of a property purchased and then securitized the debt, and later sold. LADR was a 90% partner in the deal and the overall IRR on capital invested was 34.7%.
Other select investments include an office complex in Michigan and 427 condo units in Las Vegas. Both investments appear to provide significant equity upside in excess of book value.
So it's not as complicated as some think, because LADR converted to a REIT the structural benefits allow the company more efficiency of capital flow. Accordingly, the REIT structure appears to fit more squarely (no pun intended as it relates to the triangle) into LADR's business model given the compelling profits and enhanced potential for growth (in normalized book value).
Multiple Levers, Reduces Risk
As noted above, LADR was more cautious in originating loans targeted for securitization due to extreme volatility that was prevalent in credit markets at the start of the year. Thus, the company originated just $69.4 million of loans held for sale and $49.7 million of balance sheet loans.
Instead of originating a customary pace of securitized loans, LADR instead allocated capital internally and repurchased $55.7 million worth of corporate bonds and $4.7 million of common stock. LADR participated in two securitizations during the quarter contributing a total $249.2 million of loans for gain on sale of $3.9 million and a profit margin of 1.57%.
The reason for the pull back on originations for sale in the quarter was because the company prices loans that could be sold profitably at the requisite credit spreads that were prevalent in the first quarter. The mortgage rate LADR would have needed to charge to originate would not have met the company's credit standards.
When the securitization market becomes volatile, it's important to reallocate capital into other product lines investing in securities and more liquid investments that are usually priced at attractive levels during these periods of high volatility.
As an illustration of these values, LADR bought and sold a double AA bond in only 42 days at a gain of 9% as spreads tightened into early April. The company also bought and sold an A-rated bond in just 32 days for a gain of 16.1%. It's this multi-lever approach that makes LADR one of my top commercial mREIT picks.
Maintaining Financial Flexibility
Around 95% of LADR's debt investment assets are senior secured, including first mortgage loans and commercial mortgage-backed securities secured by first mortgage loans which are consistent with the senior secured focus of the company.
At the end of Q1-16, LADR's total unencumbered assets including cash were $658.7 million reflecting a 1.17:1 ratio to unsecure debt outstanding with total of $563.9 million. Average coupon on the loans held for sale that were originated in the first quarter was approximately 5.05%, compared to 4.14% in the comparable quarter of the prior year. The weighted average loan to value ratio in Q1-16 was approximately 66.4%.
LADR maintains a consistent focus in match-funding and counterparty diversity.
In a rising interest rate environment, LADR expects to benefit from: (1) $1.2 billion floating rate balance sheet loan portfolio (2) $1.7 billion of fixed rate borrowings with remaining terms greater than one year (3) $1.0 billion (notional value) of interest rate hedge positions that place LADR in a position equivalent to that of a "fixed rate payer/floating rate receiver" (4) LADR estimates that a 100 basis point increase in LIBOR would result in an increase in annual net interest income of approximately $5.5 million.
Ladder ended the quarter somewhat smaller, but with a more liquid asset base, total assets of $5.7 billion versus $5.9 billion at the end of 2015 levered at 2.76:1 compared to 2.87:1 at the end of last year.
Looking more closely at the balance sheet, LADR originated $119.1 million of loans, and the portfolios of loans held for sale were at $353.3 million at the end of the quarter. The portfolio of loans held for investments were $1.6 billion, down 9.54% from the end of last year due to loan repayments. The portfolio of CMBS and US Agency Securities increased to $2.6 billion from $2.4 billion at year-end 2015, reflecting the reallocation of capital to CMBS.
Saving The Last For Best
By now, you have a general understanding of how LADR makes money and while the business model is not as simple as BXMT, the multi-channel platform provides ample cash flow for dividend investors.
The "triangular" approach outlined above appeals to my "sleep well at night" mindset, and I especially like the company's conduit securitization business that generates outsized ROE.
The payout ratio provides an added margin of safety in which I'm not necessarily worried about the likelihood of a dividend cut. The $.275 per share quarterly payout is adequate to cover the earnings generated. In the first quarter, LADR reported core earnings of $38.2 million and core earnings per share of $0.38.
Now let's examine LADR's dividend history compared with the peer group:
Before you get nervous, remember that in 2015, LADR paid out a special dividend (partly in stock) as a true-up distribution in December and the company will likely do the same again in 2016. As I reflect on LADR, I'm reminded of the disciplined approach of managing risk within the senior management ranks. While most commercial mREITs pay out close to 100% of earnings, LADR maintains a more conservative strategy in which the company pays out around 70% of earnings.
So the reality is that LADR's current dividend payout represents a portion of the reward and at the end of the year, it's ho-ho-ho time. Here's LADR's dividend yield compared with the peers:
In addition to the dividend metric, LADR is also cheap on a price to book basis (book value is $13.46 or .9x) and price to earnings (2016 EPS is $1.50 and P/E is 8.2x).
In conclusion, LADR is well-capitalized and while rates have tightened, transactional volume has increased. The uncertainty regarding the CMBS business should normalize in 2016, and LADR is well-positioned to capitalize on growth in that segment. I'll summarize the key differentiators now:
- LADR is internally-managed
- LADR has multiple products offering diversified revenue
- LADR has a real estate portfolio
- LADR has a low pay-out ratio (with a true-up at year-end)
- LADR insiders own 11.9%.
The overhang, in my opinion, is overblown as LADR is depressed based on technicals, but credit fundamentals are strong, making the case that risk retention is the secret sauce that will enhance LADR's visibility.
In closing, I find LADR to be a solid BUY and if you're wondering why I titled the article "Nothing Can Trump This REIT," it's because LADR is also a lender to the Republican Party nominee, Donald J. Trump.
As I wrote in my upcoming book, The Trump Factor, LADR has provided financing for numerous Trump-owned buildings including Trump Tower located along Fifth Avenue (where Trump borrowed $100 million in 2012). My book should be on Amazon in a few days and I examine all of the details of each and every asset owned by the billionaire in great detail.
Author's Note: Brad Thomas is a Wall Street writer and that means that he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and I assure you that he will do his best to correct any errors if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research (Thomas is the editor of a newsletter, Forbes Real Estate Investor), while also providing a forum for second-level thinking. If you have not followed him, please take 5 seconds and click his name above (top of the page).
Sources: FAST Graphs, SNL Financial and LADR Presentation.
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
Disclosure: I am/we are long O, DLR, VTR, HTA , STAG, GPT, ROIC, HCN, OHI, LXP, KIM, WPC, DOC, EXR, MYCC, TCO, SKT, UBA, STWD, CONE, BRX, CLDT, HST, APTS, FPI, CORR, NHI, CCP, CTRE, WPG, KRG, SNR, LADR, PEB, BXMT, IRM, CIO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.