One of the fears stalking many investors that own higher yield financial stocks and REITs is what will happen when interest rates start to increase. Commercial mortgage REIT Blackstone Mortgage Trust (NYSE:BXMT) offers the combination of a current high yield and a business model that will generate higher profits if/when short-term interest rates start to rise.
Uncomplicated Business Story
Unlike some of the residential MBS-focused REITs, the Blackstone Mortgage Trust story is a straightforward operation of a commercial mortgage lender. Yet as a REIT, this commercial lender can take advantage of a range of market tools to generate an above average yield and return for investors. A rundown of the Blackstone Mortgage operations sets up the investment potential discussion.
Blackstone Mortgage Trust is managed by The Blackstone Group LP (NYSE:BX). Blackstone is a global leader in real estate investing, with over $136 billion of owned real estate and $78 billion of real estate debt. The business operations of parent Blackstone function as a ready source of commercial mortgage opportunities that fit the criteria desired by Blackstone Mortgage Trust. The REIT makes mortgage loans across the U.S. and Europe with the current loan portfolio weighted about 60% weighted to New York, California and the U.K.
Blackstone Mortgage makes commercial mortgage loans of $50 million to $500 million. Company guidelines are loan amounts of 60% to 80% loan-to-value. As of November 2014, the portfolio had a weighted average LTV of 64%. Blackstone Mortgage works in loan sizes where there is little competition and the company requires borrowers to retain a healthy portion of a property's equity. Since May 2013, when the REIT was refocused to the commercial lending market, the average loan size has been $89 million.
Blackstone Mortgage only makes variable rate loans. 100% of the company's net book value is backed by floating rate loans. The minimum borrowing rate is Libor plus 3.5%, with most loans at a higher rate, scaled to risk. At the end of the 2014 third quarter, the portfolio yield was at Libor + 4.97%. The REIT's all-in borrowing costs are Libor plus 1.7% to 2.0%, resulting in a typical 2% plus spread on the portion of a loan Blackstone chooses to fund through debt financing. Borrowing is matched term, index and currency to originated loans. Blackstone will retain a significant portion of the equity in a loan. In an example loan from a recent presentation, BXMT shows that by borrowing 80% of a new Libor + 4% mortgage and retaining 20%, the equity portion generates a Libor plus 7.5% to 8.5% net return.
In May 2013, Blackstone repurposed BXMT, which had been basically mothballed as a REIT, and started to manage Blackstone Mortgage Trust as one of a very small number of pure play, commercial mortgage originating REITs. Since May of last year through September 2015, the REIT had originated 58 loans for a total of $5.2 billion. To date, Blackstone Mortgage has put just $1.4 billion of equity to work in a $3.3 trillion commercial mortgage market. There is a huge market for this $1.65 billion market cap REIT to grow into.
The primary risk to the investment returns from BXMT would be a significant decline in the value of commercial property across the spectrum of property types. A falling commercial market would put Blackstone's equity at risk and slow or stop the demand for new commercial mortgages.
For the third quarter, Blackstone Mortgage increased its dividend to $0.50 per share, up 4% from the $0.48 paid over the previous two quarters. Going forward, dividend growth will come from a combination of continued portfolio growth, operational efficiencies, and the potential for higher short-term interest rates. With both its portfolio loan rates and borrowings indexed to Libor, Blackstone management notes that as rates increase, so will the net profit for the company. The company has stated that a 1.0% increase in Libor would add $15 million or $0.26 per share in net interest income. During the third quarter conference call, management said that it expects the BXMT quarterly dividend to increase in parallel with any increase in short-term interest rates.
With a current 7% yield and dividends that will increase with higher interest rates, Blackstone Mortgage Trust is a compelling story for income focused investors.
Disclosure: The author is long BXMT.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.