KKR and Blackstone REITs to benefit from reopening
Finding a room at the Westin Maui Resort & Spa can be more difficult this summer, as Hawaii eases travel restrictions. It’s a tough break for vacationers looking for a luau. But it’s good for the company that holds a $ 363 million mortgage on the property:
Blackstone Mortgage Trust.
“We have made a number of loans in Hawaii and are bullish on the fundamentals,” says Katie Keenan, president of Blackstone Mortgage (ticker: BXMT). “As the travel industry recovers, pent-up demand will be of great benefit to Hawaii.”
Commercial real estate is booming as demand for investment property heats up. There are pockets of weakness, especially in retail, office and hospitality. But some of the biggest commercial lenders have come out of the downturn in great shape, and with plenty of cash available to fund properties, which will increase their income and increase dividend income for investors.
Two of these companies, Blackstone Mortgage and
KKR Real Estate Finance Trust
(KREF), looks attractive. While they don’t offer much growth potential, they each bring in around 8%, based on the annualized payments of their last distributions. And as improving commercial real estate trends increase their assets, they should be able to maintain or increase their distributions.
One of the reasons for owning mortgage trusts is their connection to two private equity giants:
(KKR). Blackstone Group is one of the world’s largest private equity real estate owners, managing $ 196 billion in assets. KKR oversees $ 16 billion in real estate assets. Private equity firms hold interests in and supervise mortgage trusts. The parent managers are connected at the conclusion of the transactions and make potential loans to the trusts.
Blackstone Mortgage closed $ 1.7 billion in new loans in the first quarter, bringing its total to $ 18.7 billion in loan assets. The company aims to grow its asset base to $ 20 billion with existing capital, including $ 1.1 billion in cash and available credit.
About half of its portfolio is in office buildings, followed by 17% in hotels and 12% in apartment buildings. It is making new loans in areas such as life sciences and logistics, including a recent loan of $ 575 million for a package of logistics goods and “last mile” warehouses in Sweden.
While the pandemic has caused a wave of defaults on business loans and late payments, Blackstone sees minimal impact; 98% of its loans were performing in the first quarter. Blackstone has considerable exposure to the office market, but it is focusing on newer buildings with flexible fittings and layouts, says Keenan, where demand is resisting. “We lend to high quality borrowers and are very demanding,” she says. Overall, the average portfolio loan-to-value ratio is 65%, which implies a decent real estate value cushion.
Blackstone’s loan portfolio has an average maturity of 3.1 years; then the loans are either refinanced or repaid. The loans have a variable interest rate based on the London One-Month Interbank Offered Rate, or Libor, a short-term benchmark, currently at 0.1%. The average yield is Libor plus 3.6%.
Even so, higher short-term rates would be a headwind for Blackstone. They would increase its capital costs and interest income would not increase in parallel, as many of its loans have high Libor floors that protect borrowers from rate hikes up to a point. Libor would likely need to hit 1.5% for interest rates on Blackstone’s portfolio to adjust significantly higher, says BTIG analyst Tim Hayes. Another headwind, he adds, is that competition for investment property is intensifying, given the high level of liquidity in private equity. “Asset returns on new loans go down,” he says. However, funding costs have also declined, so returns on equity are expected to be in line with pre-pandemic levels. Blackstone is trading at 1.2 times its estimated book value for 2021, a premium valuation that is likely limiting the rise in its stock.
However, Hayes recommends the REIT for the company’s credit metrics and healthy dividend coverage. He also likes his loan pipeline, attached to Blackstone Group, and he believes there are still benefits, expecting his shares to hit $ 35 over the next 12 months, up from $ 30.58 recently.
KKR Real Estate is a small mortgage trust with a portfolio of $ 5.3 billion. Apartment buildings and offices constitute 85% of its portfolio, the rest being in shops and hotels. It is also a variable rate lender, with an average yield of 3.4%. And its Libor floor is similar to Blackstone’s, at 1.4%.
KKR Real Estate lends to borrowers who need a short-term loan to acquire, refinance or renovate a property, says CEO Matt Salem. Most of its apartment loans are for new rental construction; buyers need time to fully lease them before selling the buildings, and they take out bridging loans for the transition. “It’s a pretty defensive loan profile,” says Salem.
Parent company KKR is also creating a lending channel; Over the past 12 months, the REIT has reviewed $ 44 billion in financing opportunities and issued $ 918 million in loans. The company says it has $ 571 million in cash to fund new loans. KKR sold five million shares of the REIT, or a quarter of its stake, last week, and the stock was hit 5% by the sale. But it won’t dilute earnings or book value and increase the stock’s liquidity, potentially expanding the investor base to more institutional buyers.
KKR REIT’s office buildings are mostly found in high-demand cities including Boston, Philadelphia, Seattle, and Washington, DC Loan-to-value ratios for offices average 62%, Salem adds, implying that properties are expected to lose nearly 40% in value before mortgages are diminished.
At around $ 20 a share, KKR Real Estate is trading above its estimated book value of $ 19. It doesn’t imply a lot of benefits; in fact, the average target for analysts is $ 21.43. But if the company maintains its latest quarterly distribution of 43 cents a share, investors would reap an annualized return of 8.6%. That would be more than double the 3.7% return on junk bonds these days.
Assuming that demand for offices, hotels and apartments holds, both stocks could generate income in a low yielding world.
Write to Daren Fonda at [email protected]