Real Estate Investment Trusts (REITs) that engage in commercial real estate lending and financing are celebrating some good recent news for both the sector and the shareholders who invest in REITs, such as Apollo Commercial Real Estate Finance (ARI).
First, the National Association of Realtors released its commercial real estate forecast late last month, and generally speaking, it’s a pretty upbeat outlook for the rest of the year.
The association’s report says that the commercial real estate market should continue its upswing. Vacancy rates for offices, industrial markets and retail markets are all expected to decline.
The association’s chief economist, Lawrence Yun, provides detail:
“The commercial real estate sector is on the path to recovery, but subpar economic growth, lack of financing available to small investors and the industry trend towards squeezing more employees into existing spaces will keep demand from meaningful acceleration. The exception is multifamily housing, which remains the best performer with vacancy rates under 4 percent in several markets in the Northeast and in California.”
Yun said that as long as jobs are being added and the economic recovery continues, the association can expect to see increases in commercial space demand.
The Federal Reserve also has kind words for commercial real estate in its recent Beige Book Release. The Central Bank said that “commercial real estate leasing and construction activity improved in most districts, and outlooks were optimistic.”
It added that commercial real estate financing was steady in the Kansas City district, while growing in the New York, Cleveland, Chicago and Dallas districts.”
As I said, great news for commerical real estate REITs.
As banks have stepped back from many types of lending, these REITs are seeing an opportunity to get more involved and seeing loan proposals from a wider variety of projects and borrowers.
Last week, Keefe Bruyette and Woods analysts Jade Rahmani and Ryan Tomasello said that REITs that invest in commercial real estate have a bright future, and cited four reasons for their bullish outlook:
- “Although interest rates are low, credit spreads are wide enough to generate attractive levered returns;
- The pipeline of (commercial real estate) debt maturities through 2018 should create significant refinance and investment opportunities;
- Continued economic growth and modestly improving real estate fundamentals suggests strong credit performance on loans originated to date while underlying real estate equity values continue to increase; and
- Given the regulatory environment, banks and conduits remain reluctant to lend on transitional assets.”
Commercial lending REITs are perfectly positioned to take up the slack here.
My favorite commercial real estate-lending REIT remains Apollo Commercial Real Estate Finance. ARI’s association with global alternative asset management and private equity firm Apollo Global Management (APO) means that it sees deals no one else ever gets a peek at — and that is a huge edge over competitors.
ARI originates, invests in, acquires and manages performing commercial first mortgage loans, subordinate financing, commercial mortgage-backed securities and other commercial real estate-related debt investments across a wide spectrum of property types.
The loan portfolio is incredibly well-positioned, with 61% of the loans floating rate and the fixed rate portion having an average life of just four years and an interest rate of 10.2%. The loan-to-value ratio of the portfolio is just 62%, so there is a margin of safety built into their loans.
The commerical real estate lending market should be very robust over the next several years. Refinancing alone should be a huge source of business as $1.4 trillion of commercial real estate loans will be up for refinance over the next five years.
Combined with new activity that develops as the economy improves and ARI is well-positioned to continue growing its loan portfolio on favorable terms. The stock is very attractively priced right now, with the shares trading at just 81% of asset value and yielding 10.3% at the current quote.
As of this writing, Tim Melvin is long ARI. He is the author of the Banking on Profits newsletter covering the community bank stock opportunity and the Deep Value Report that seeks out undervalued stocks that are likely to survive until they thrive and capture the value effect that has been proven to beat the market over time.
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