Apollo Commercial's 11.8% Yield Is Too Dangerous
Summary
- Apollo Commercial’s stock has seen a meaningful recovery in recent weeks.
- The trust covered its dividend with distributable earnings in 3Q-22.
- High payout ratio doesn’t create confidence for passive income investors.
Phiwath Jittamas
The stock price of Apollo Commercial Real Estate Finance Inc. (NYSE:ARI) has increased in recent weeks, but the commercial mortgage real estate investment currently does not provide a high level of dividend coverage.
The most crucial factor for passive income investors is that their investments are generating a steady stream of income, which Apollo Commercial Real Estate Finance, in my opinion, cannot provide.
I believe there are better alternatives for investors seeking passive income in the CRE trust sector, despite the fact that the trust's stock is currently trading at a sizeable discount to book value.
Originations And Portfolio Status
Apollo Commercial Real Estate Finance typically engages in first mortgage loans of excellent quality that are backed by collateral from various real estate sectors.
As of September 30, 2022, First Mortgages made up the majority of the trust's investments (92%) while Subordinate Loans made up a smaller fraction of the portfolio (8%).
The hotel, office, residential, and retail sectors all continued to get a significant amount of exposure from Apollo Commercial Real Estate Finance, with cyclical hotels making up the largest portfolio of the trust's collateral at the end of the quarter.
Portfolio Status (Apollo Commercial Real Estate Finance Inc)
In the third quarter of this year, Apollo Commercial Real Estate Finance committed $388 million to the origination of new mortgage loans, bringing the YTD total to $3.5 billion. At the conclusion of the September quarter, the trust's portfolio was valued at $8.7 billion, a $206 million fall QoQ principally as a result of repayments and Forex impacts.
Portfolio Activity (Apollo Commercial Real Estate Finance Inc)
Dividend Covered By Distributable Earnings, But Pay-Out Ratio Is Too High
In the third quarter, the commercial mortgage real estate investment trust generated distributable earnings of $0.37 per share, exceeding the $0.35 dividend distribution threshold.
In the third quarter, Apollo Commercial Real Estate Finance paid out 95% of its distributable income in dividends, a little improvement over the preceding quarter when it paid out 100% of its distributable income.
Passive income investors shouldn't have much faith in the trust's dividend because ARI paid out an unsustainable 101% of its distributable revenue over the past year, especially if home loan originations fall.
Dividend (Author Created Table Using Trust Information)
High Discount To Book Value Reflects High Risks
Apollo Commercial Real Estate Finance has the least consistent dividend of all the commercial real estate investment trusts that I have lately studied, including CRE trusts like Starwood Property Trust, Inc. (STWD), Ladder Capital Corporation (LADR), and Blackstone Mortgage Trust, Inc. (BXMT).
Since the trust paid out more than 100% of its distributable earnings in the previous year, as I mentioned above, a decline in mortgage originations and distributable earnings would have a serious negative impact on the trust's ability to fund dividends.
The CRE trust that I now favor the best is Starwood Property Trust because of its diversification (the company has both a servicing sector and a property investment division) and a strong track record of maintaining dividend payments.
Apollo Commercial Real Estate Finance is now the cheapest CRE trust in the industry because it is selling at a 31% discount to book value.
Why ARI Could See A Lower Valuation
The biggest possible challenge Apollo Commercial Real Estate Finance is now experiencing is a decline in origination volumes in the commercial real estate industry.
Given the recent increase in the likelihood of a U.S. economic recession, I would not feel particularly secure owning a cyclical real estate business with such a low dividend coverage ratio.
My Conclusion
Simply put, I believe there are superior CRE financing options to Apollo Commercial Real Estate Finance. Even though the company is currently trading at a sizeable discount to book value, I have little faith in ARI's 11.8% dividend yield.
Even a slight decrease in distributable earnings, which the trust could experience due to a collapse in the commercial real estate market, would have a negative impact on the pay-out ratio and might even require ARI to reduce its dividend.
Given the rising economic uncertainties, I believe it would be far wiser to invest in and overweight CRE trusts like Starwood Property Trust that are most likely to continue providing a steady dividend even if the market declines.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.