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When the economy shut down in March, I saw a lot of genuine fears that commercial real estate markets would collapse.
That would have crushed commercial real estate lenders and possibly pushed the U.S. economy into a full-blown Depression.
Commercial lenders' collapse would have threatened the banking system as losses from bad loans spiraled out of control.
I wasn't the only one concerned.
Real estate investment trusts (REITs) that make commercial loans were crushed in the sell-off, with some industry leaders losing as much as 75% or more of their market value.
Then the Fed stepped in with trillions of dollars in fiscal stimulus programs. Congress passed extended unemployment and one-time stimulus payments to individuals to keep the economy afloat.
Figures from the National Association of Real Estate Investment Trusts show that rent payments have been relatively high for all segments of the market except for retail and senior living facilities.
The commercial mortgage REITs have recovered some of their losses too.
Simply put, investors overreacted to fears over real estate that never materialized. And that's creating the perfect buying opportunity right now. Not only are these REITs underpriced, which means they will pop higher soon, but the lower price means their yields are much higher than normal. That adds even more cash to your portfolio.
What makes July such a good time to buy is the coronavirus pushed back the real estate market's seasonal peak from the spring to late summer. Plus, Congress is ready to pass even more stimulus measures, which will add another backstop for this lucrative market.
At current prices, the best-managed and strongest commercial mortgage REITs have high yields and excellent prospects for substantial gains over the next year...
The Best REIT to Buy Is on Sale
KKR Real Estate Finance Trust Inc. (NYSE: KREF) shares fell by more than 50% during the March sell-off but have now recovered about half of the decline. This REIT's sponsor and largest shareholder is an alternative investment giant, KKR & Co. Inc. (NYSE: KKR), so it has deep pockets available and draws on the expertise and relationships of KKR. It also helps that 85% of its portfolio comprises multifamily and office property types, while only 8% is hospitality and retail.
The balance sheet is in solid shape at KKR Real Estate Finance. It has $370 million in cash and about $80 million left on its credit line. Seventy-three percent of its debt is non-mark-to-market and unlikely to force a margin call or default based on swings in the markets. The average loan to value in the portfolio is just 66%, so it would take an epic collapse in commercial real estate for the firm to lose money. Even if the loans defaulted, KREF should be able to recoup its money by selling the properties.
The board feels pretty good about the future of the company too. So far this year, they have repurchased 2,037,637 shares of stock. Almost 370,000 of those were bought in April as the stock began to recover lost ground.
At the current price, the REIT yields a little over 10%. Also, the stock has to move higher by at least 25% to recover the rest of the March decline in the shares.
This is simply one of the best REITs available thanks to the connection to KKR and its elite management, and this price and yield won't last long.
The Best REIT to Own During a Crisis
Ladder Capital Corp. (NYSE: LADR) fell by about 80% during the initial sell-off as investors were sure that the REIT was going to collapse due to commercial real estate defaults.
The markets seemingly forgot that Ladder was born during the credit crisis, and the management team knew what they had to do to survive.
Ladder entered into a strategic financing arrangement with Koch Real Estate Investments, an affiliate of Koch Industries, under which Koch will provide the company with approximately $206.4 million in senior secured financing to fund loans. The company also announced the completion of a private CLO with Goldman Sachs Bank USA, which generated $310.2 million of gross proceeds to Ladder.
When all was said and done, Ladder had $830 million of cash on hand and over $2.6 billion of unencumbered assets. Most of the loans are senior-first mortgage loans, and the securities portfolio is primarily AAA-rated commercial mortgage-backed securities. The portfolio continues to throw off cash, and for the first quarter, Ladder Capital was profitable with core earnings of $26 million.
Ladder Capital did cut the dividend to preserve cash, but even after the cuts, the REIT yields almost 10%. The stock price has to more than double to get back to the pre-pandemic highs, so the total return potential is enormous here.
Of course, not all REITs are going to bounce back. We've targeted companies with excellent management, balance sheets, and operations in the right markets. These got punished during the mass sell-off in March.
Unfortunately, some companies deserved to get sold...
Steer Clear of This REIT
Colony Credit Real Estate Inc. (NYSE: CLNC) has been an absolute disaster since being spun off from Colony Capital Inc. (NYSE: CLNY) two years ago. The REIT has cut dividends on multiple occasions. Its loan quality was poor, and it has had to take several asset write-downs that reduced book value. Most of that was happening before the pandemic began, and the situation has worsened amid the volatility in the commercial real estate markets.
Colony Credit has suspended the dividend to conserve cash. You get paid nothing and are just making a highly speculative, highly leveraged bet that the new management installed back in March can turn around a very troubled ship.
Most investors are best served by passing on that bet.
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About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.