As a committed, passionate, and experienced REIT analyst, part of my steadfast research includes observing principles I can rely on time after time, to deliver alpha and deliver results – and then, share my findings. That’s part of why I present these columns in The Property Chronicle.
Today, I want to illuminate a principle of competitive advantage. One way of saying this, is knowing how to “play the system.” But that’s too ordinary for me, and borders on a lack of integrity. I much prefer “using the system.”
Here’s an excellent example in the REIT marketplace of such a competitive advantage. It’s one that can provide readers with a valuable investing insight – and highly sustainable dividends.
Blackstone Mortgage Trust (NYSE: BXMT) is a REIT that primarily originates and purchases senior mortgage loans collateralized by properties in the U.S. and Europe. The New York-based REIT is managed by “big brother” Blackstone (BX), a world leader in alternative investments with nearly $440 billion of assets under management (AUM).
“Big brother” BX operates with significant scale in each of the four key alternative categories: Real Estate ($119.4B AUM), Private Equity ($119.5B AUM), Credit ($123.1B AUM), and Hedge Fund Solutions ($77.4B AUM). And that $119.4B number makes BX one of the world’s largest commercial real estate investors.
Around three years ago, “Little Brother” BXMT completed an equity offering, raising $660 million in growth proceeds – a strong indication of the growth potential of the simple floating rate senior mortgage business plan. Limited new commercial real estate construction, coupled with modest growth, has led to a more favorable investment environment for senior commercial real estate debt.
BXMT’s relationship with the “big brother” (Blackstone Real Estate) offers a huge advantage in which the former’s access to proprietary deal flow and property and market information is a valuable differentiator, given the scale of BX’s real estate business.
As part of Blackstone Real Estate, “little brother” BXMT is uniquely positioned to obtain market-leading credit opportunities. The low cost and superior structure of financing enhance the returns on the REIT’s loans.
Simply said, BXMT’s connection to Blackstone Real Estate allows the company to benefit on both sides of the balance sheet. Blackstone Real Estate is a premier debt and equity investment and asset management platform.
BXMT is externally managed (most commercial mortgage REITs are, except Ladder Capital Corp. (NYSE: LADR)), and so, BXMT and BX are essentially the same management team. BXMT’s real estate debt people are the originators and asset managers for both BX and BXMT.
BXMT is the senior vehicle, but there are other vehicles at BX, managed by the same team, for different strategies which are not public. BX has access to deal flow, attractive financing terms (where the companies leverage the entire BX relationship with the banks), underwriting/asset knowledge, reputation and brand, etc.
As many readers know, I’m normally not a proponent of externally-managed REITs, but I pay close attention to the commercial mortgage REITs (“mREITs”) because I believe that they provide a valuable place setting for retail investors.
BXMT charges a 1.5% management fee on equity and a 20% incentive fee on gains above a hard hurdle of 7% (no catch-up gains below that), with a look back. General and administrative expenses (G&A) include management and incentive fees, as well as other G&A expenses for the REIT.
A simpler commercial mortgage REIT
I focus on REITs with lasting repeatability, and for me, dividend sustainability is the ultimate research metric. If I’m not comfortable with the durability of the dividend, I won’t recommend the stock. So why am I recommending this commercial mortgage REIT?
Economic conditions are sustaining a favorable commercial real estate market as liquidity and fundamentals in the commercial real estate sector are generally in balance. Real estate continues to benefit from limited supply and moderate growth.
The macroeconomic backdrop for commercial real estate fundamentals is sound, fueled by job growth and positive consumer sentiment; real estate operating fundamentals have continued to improve and supply has been limited in most markets and asset classes.
Commercial real estate fundamentals are improving, which further supports the business model for real estate lending. Reluctance among traditional commercial real estate lenders, coupled with increased transaction volume, creates a compelling lending environment. CMBS and bank lenders are reducing CRE lending activity under regulatory pressure.
Blackstone Real Estate (”big brother”) has proprietary insight, long-standing expertise and superior access to deal flow, and accordingly, BXMT’s affiliation with it is a great competitive advantage. In fact, the relationship is a valuable differentiator given the scale of Blackstone’s real estate business.
Keep in mind that BXMT does not own equity interests in real estate. Part of the value proposition for investing in the specialized commercial mortgage sub-sector is the limited new supply constraints – completions are well below US aggregate construction completion levels.
This strong commercial real estate environment, marked by healthy property transaction volume, gives rise to strong borrower demand for transitional capital. BXMT is one of the most elementary commercial REITs that exists.
More detail, if you like
BXMT’s short-term floating rate assets benefit from rising short-term interest rates, as their current yields increase with these rates. REIT investors tend to fear rising rates, particularly investors in residential mortgage REITs, where many of the assets are fixed rate, but the liabilities float – but BXMT is different. Around 92% of loans are floating rate (earnings would benefit from increased short-term rates).
The company’s loans are LIBOR-based and insulated from the valuation impact of rising rates. Its credit facilities are also LIBOR-indexed and match fund assets. As a result, equity returns directly benefit from increases in LIBOR. When rates rise in tandem with better economic activity, the real estate underlying the loans will generate higher cash flows.
The credit quality of BXMT’s portfolio remains strong overall, and you can read their entire Q2-18 results on their website.