2 Buy Alerts: 10% Dividend Yield And Good Risk/Reward

Today, the average dividend yield of the REIT sector is right around 3%. Some of the most popular REITs like Public Storage (PSA), Prologis (PLD), and American Tower (AMT) yield even less than that.

I don’t know about you, but 3% just doesn’t cut it for me. If I am going to invest in real estate, I want to get paid generous rental income while I wait patiently for long-term property price appreciation.

That’s why we called our investment community, High Yield Landlord, here on Seeking Alpha.

We target undervalued real estate investments through the often-mispriced REIT market in an attempt to earn a 5-8% dividend yield and additional upside from growth and multiple expansion.

This high-yielding approach to REIT investing has served me well over the years and allowed me to outperform the lower-yielding REIT ETFs (VNQ).

But high yield also comes with higher risk and not all our investments are successful. In fact, it is quite common for our investments to underperform for a while before our thesis finally plays out.

In today’s article, we will highlight two of our recent underperformers that have become deeply undervalued. They yield upward of 10% and we believe that they have significant upside potential as they recover in the coming years.

Broadmark Realty Capital (BRMK)

Our investment in BRMK is quite recent and our losses are not significant. Counting dividends, we are currently down ~10% on our investment, which is rather surprising when you consider that we are living through one of the biggest housing booms ever, and most of their loan collaterals are residential properties.

What caused its share price to decline?

There are four main reasons:

First off, today, about 12.9% of their loan portfolio is in default. This sounds like a lot, but this is nothing unusual for hard money lending. You lend money at high interest rates with the exception that some of your projects will fail and you mitigate risks by having good collateral.

Secondly, the management noted that the competition is rising in hard money lending, which puts pressure on their interest rates and fees. To remain competitive, they may need to lower their rates, which then lowers the profitability of their business model. I suspect that this is one of the reasons why they decided to discontinue their private REIT which was earning them management fees. Their pipeline is not large enough, and therefore, they prefer to keep all the deals for themselves.

Thirdly, the company recently hired a new CEO, which may worry those investors who didn’t follow BRMK’s management transition plan. This had been announced a while back, but it causes uncertainty nonetheless. As an example, will the new CEO push for a dividend cut? Will he change the business plan? Will he lower interest rates to remain competitive?

Finally, the dividend of the company still isn’t fully covered and many fear that it may be cut, causing them to sell the stock in anticipation of that.

This is all bad news that justifies a lower share price. Defaults increase risks. Competition lowers profitability. Management transitions cause uncertainty. And the risk of a dividend cut could cause more volatility.

As a result, our investment thesis is deteriorating. But is it deteriorating to the point that we should sell and take our loss?

We don’t think that we are there yet, especially at today’s lower share price, which affords more margin of safety. All the points mentioned earlier may seem very negative, but it is not quite that bad.

Concerning defaults: During the last year, BRMK managed to reduce the default rate by 3.6% by foreclosing on some properties or collecting late payments from borrowers. The management noted that they remain confident that they will reach a positive outcome on most of these defaulted loans. They are confident because most of them have the construction nearly or fully complete and the collateral is mostly residential properties in rapidly growing markets. Today, residential properties are appreciating in value so time is on our side. Can we trust the management’s judgment? In their ten-year history, they have only lost about 0.3% on $3.7 billion of loans originated. That’s a good track record in this field.

Concerning the rising competition: BRMK still managed to originate record loan volume in the third and fourth quarters. Moreover, while interest rates/fees may drop, BRMK is also lowering its cost of capital by adding debt to its balance sheet, which remains extremely conservative. The company recently issued $100 million of debt at a 5.0% interest rate in a private placement to fund portfolio growth.

Concerning the new CEO: New leadership always creates uncertainty, but the new CEO sure seems to have the right background for the job. Mr. Ward previously served as the CEO of Trimont Real Estate Advisors, a commercial real estate asset management firm that specializes in complex performing and non-performing credit investments on behalf of commercial real estate lenders and investors around the world, with aggregate invested capital under management of $168 billion. He presently serves on the Alumni Board of Advisors for Harvard Business School, the Harvard University Alumni Real Estate Board, and the New York University Schack Institute of Real Estate Board. I would add that the former CEO will retain the role of Chairman.

Concerning the new dividend: While its sustainability is at risk, the new CEO didn’t push for a cut yet. Perhaps, he is seeing light at the end of the tunnel. Instead of giving false hope to shareholders, he probably would have cut it by now if that was the plan.

The bottom line: is that the thesis has deteriorated, some of the risk factors have played out, but priced at $8.30 per share, we continue to like the risk-to-reward of the company. It is currently priced at a near 10% dividend yield, which even after a cut, would remain substantial, and if they can work down their book of defaulted loans, then we would expect the share price to quickly recover closer to $10 per share.

They explain in the most recent conference call that they expect to be more aggressive in foreclosing, which I think indicates that they are confident in the value of their collateral. To repeat ourselves: BRMK has a fantastic track record in this space and that gives us enough confidence to hold on to our small position.

For now, it continues to serve its purpose in our diversified portfolio: it boosts our average yield and adds a lending component to our real asset-heavy portfolio.

CorEnergy Infrastructure Serie A Preferred Shares (CORR.PA)

CORR.PA is the worst-performing and riskiest investment in our Retirement Portfolio. CORR has a troubled past and common shareholders were almost wiped out in 2020 when oil prices turned negative and its biggest clients defaulted on payments, forcing it to sell assets at pennies on the dollar.

Saying that the management has failed to deliver would be an understatement. Common shareholders are rightfully frustrated.

But it is also fair to say that black swans happen and it doesn’t necessarily make the entire capital structure uninvestable.

In our case, we are invested in the preferred shares of the company, which we believe have enough buffer following CORR’s transformative acquisition of Crimson last year.

We think that this transaction benefits CORR’s preferred shareholders, possibly at the expense of common shareholders. It provided the company a more stable base of cash flow from utility-like assets that can be used to service the preferred shareholders and it also greatly expanded the asset buffer that supports the preferred equity.

CORR has guided to earn $45 million of EBITDA in 2022, which should be plenty to meet all its obligations and pay the preferred dividend. In fact, there is even enough cash flow to pay a $0.20 dividend per share to the common shareholders.

We are also reassured by the management’s willingness to cut G&A to further increase dividend coverage and improve the financial sustainability of the company. The management also created a second class of common shares for themselves that have a lower priority for dividend payments, acting as a shock absorber if necessary. This is indicative of a well-aligned management team. Here is what the CEO commented in the most recent conference call:

“We reorganized our operations, reduced costs, and strengthened dividend coverage all to the benefit of our common holders going into 2022. This includes the reduction in management fees and simplification of the capital structure both of which followed stockholder approval.

The net takeaway of these actions should be that while our common stock was already in a good dividend position, these steps provide even greater confidence of coverage for our common holders with subordinated management-owned shares acting as a shock absorber if necessary.”

The bottom line is that we remain confident that the preferred dividend is sustainable unless something major changes.

Risks are certainly higher than usual due to its troubled past and tighter dividend coverage, but priced at a 10.2% yield and offering 30% upside to par, we like the risk-to-reward. On a side note, I also think that Russia’s invasion of Ukraine could indirectly benefit CORR and other fossil energy infrastructure companies located in the US.

Bottom Line

Our high-yielding REIT investment strategy takes patience and courage because we are often going against the crowd.

We buy beat-up companies that are undervalued because of temporary challenges that can be fixed over time.

This allows us to earn a high yield while we wait for long-term upside.