For Immediate Release
Chicago, IL – March 8, 2024 – Today, Zacks Equity Research discusses Starwood Property Trust, Inc. STWD, Apollo Commercial Real Estate Finance ARI and Ladder Capital LADR.
Industry: REIT & Equity Trust
Link: https://www.zacks.com/commentary/2237496/3-top-rated-mreit-stocks-to-buy-amid-gloomy-backdrop
The Zacks REIT and Equity Trust industry has been affected by yield curve inversion due to high rates, credit spread volatility, spread widening, low market liquidity and limited fixed-income demand. This resulted in increased mortgage rates, significantly reducing originations. The mREIT industry is likely to witness book value erosion in the near term, as wider spreads in the Agency market affect asset prices.
Nonetheless, the Fed’s decision to conclude its rate-hiking cycle in 2024 indicates easing earnings pressure for highly leveraged mREITs that have been facing rising funding costs. Moreover, Agency markets stand to recover from the interest rate relief. Hence, companies like Starwood Property Trust, Inc., Apollo Commercial Real Estate Finance and Ladder Capital are well-poised to navigate the market blues.
About the Industry
The Zacks REIT and Equity Trust industry comprises mortgage REITs, also known as mREITs. Industry participants invest in and originate mortgages and mortgage-backed securities (MBS), and provide mortgage credit for homeowners and businesses. Typically, these companies focus on either residential or commercial mortgage markets. Some invest in both markets through asset-backed securities.
Agency securities are backed by the federal government, making it a safer bet and limiting credit risks. Such REITs also raise funds in the debt and equity markets through common and preferred equity, repurchase agreements, structured financing, convertible and long-term debt, and other credit facilities. The net interest margin (NIM), the spread between interest income on mortgage assets and securities held, as well as funding costs, is a key revenue metric for mREITs.
What's Shaping the Future of the mREIT Industry?
Conservative Approach to Impede Returns: The unfavorable scenario in MBS markets, restricted financial conditions and resultant negative fixed-income fund flows have put a strain on credit-risky assets. Hence, companies are making efforts to de-lever and de-risk their portfolios. This is likely to result in lower portfolio growth. Also, numerous companies have resorted to higher hedge ratios to reduce interest rate risks and extension risks.
While such moves may seem prudent amid the ongoing uncertainties, those will impede mREITs’ earnings power in the future. We expect robust returns to remain elusive as companies prioritize risk and liquidity management over incremental returns, at least in the short term.
Industry Resorts to Dividend Cuts as Book Values Erode: Volatility in the fixed-income markets, high interest rates, and the widening of the spread between the 30-year Agency MBS and 10-year treasury rate are affecting valuations of Agency mortgage-backed securities. Hence, mREITs will continue to see book value pressure in the upcoming period. High cost of funds is another headwind, and might reduce net interest spreads and profitability.
This scenario has compelled companies to reduce the dividend to a level, wherein it can be covered by earnings. This may discourage mREIT investors and result in capital outflows from the industry, potentially resulting in greater book value declines for companies in the upcoming period.
Purchase Volume Deterioration to Continue: The volatility in mortgage rates has created hurdles for any potential recovery in purchase originations, with buyers and sellers remaining on the sidelines. Housing affordability challenges have increased due to high mortgage rates, affecting seasonal buying trends.
Amid this lackluster housing market, mortgage originations are likely to continue to be suppressed. This has caused operational and financial challenges for originators. It may also reduce the gain on sale margin and new investment activity.r
Zacks Industry Rank Indicates Dismal Prospects
The Zacks REIT and Equity Trust industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #169, which places it in the bottom 33% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates an underperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is an outcome of the disappointing earnings outlook for the constituent companies. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group's earnings growth potential. The industry’s current-year earnings estimates have moved 13.5% down since March 2023.
Before we present a few stocks that you may want to consider for your portfolio, let us take a look at the industry’s recent stock-market performance and valuation picture.
Industry Lags Sector and S&P 500
The Zacks REIT and Equity Trust industry has lagged the broader Zacks Finance sector and the S&P 500 composite in the past year.
The industry has slumped 7.7% in the above-mentioned period against the broader sector’s rise of 17.1%. Notably, the S&P Index has grown 25.7% over the past year.
Industry's Current Valuation
Based on the trailing 12-month price-to-book (P/BV), which is a commonly used multiple for valuing mREITs, the industry is currently trading at 0.82X compared with the S&P 500’s 6.25X. Over the past five years, the industry has traded as high as 1.12X, as low as 0.39X and at the median of 0.92X.
3 mREIT Stocks Worth Betting On
Apollo Commercial: The REIT focuses on originating, acquiring, investing in, and managing performing commercial mortgage loans, subordinate financings and other commercial real estate-related debt investments.
The company’s $8.4-billion portfolio of loans is secured by properties located in the United States and European gateway cities. Moreover, 99% of lending book consists of floating-rate loans. This is a key tailwind for the company amid the current high interest rates.
The Zacks Consensus Estimate for ARI’s 2024 earnings has been revised marginally downward over the past month to $1.32. Nonetheless, its 2024 earnings are expected to rise 21.1%. ARI has a market cap of $1.55 billion.
The company has a Zacks Rank of 2 (Buy) at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Ladder Capital: This mREIT is a pre-eminent commercial real estate capital provider specializing in underwriting commercial real estate and offering flexible capital solutions within a sophisticated platform. It originates and invests in a diverse portfolio of commercial real estate and real estate-related assets, with a focus on senior secured assets.
The company’s balance sheet is well-positioned to benefit from a high rate environment. Its lending book consists of significant floating-rate first mortgage loans. With this, its earnings seem positively correlated to high interest rates. We see Ladder Capital’s conservative capital structure and modest leverage as a favorable fit amid the ongoing market disruption. Also, its negligible losses on originated investments since 2008 underline an impressive credit record.
In contrast to certain mREITs resorting to dividend cuts to navigate the choppy waters, LADR’s dividends seem well-covered, with 1.4X coverage based on Distributable EPS.
The company currently carries a Zacks Rank #2. The Zacks Consensus Estimate for Ladder Capital’s 2024 earnings has been revised marginally upward in the past month. Moreover, its earnings are projected to grow 5.9% in 2025. LADR has a market cap of $1.36 billion.
Starwood Property: The Greenwich, CT-based company operates through four segments — Commercial and Residential Lending; Infrastructure Lending; Property; and Investing and Servicing.
Starwood Property had a $17.57-billion diverse loan portfolio as of Dec 31, 2023. Multifamily loans, U.S. office loans and hotel loans accounted for 21%, 10% and 8% of its $27.3-billion asset base.
STWD leverages its global multi-cylinder platform to make investments. Also, the company had primarily floating-rate assets, positioning it well to navigate the current environment.
The Zacks Consensus Estimate for the company’s 2024 earnings has been revised 2.5% downward to $1.95 over the past week. Moreover, its 2024 NII is pegged at $2.09 billion, indicating a year-over-year uptick of 2.15%. Starwood Property carries a Zacks Rank of #2 at present. STWD has a market cap of $6.35 billion.
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