Arbor Realty Trust: Why This 10.8%-Yielding Multifamily Lender Outperforms (NYSE:ABR)

Arbor Realty Trust (NYSE:ABR) is an internally managed mortgage REIT (“mREIT”) primarily focused on multifamily loans. The mREIT’s three primary segments are:

• Balance sheet loans, originated and held on the balance sheet
• Government-sponsored agency (Fannie/Freddie) loan origination, a capital-light way to generate income without long-term ownership risk
• Loan servicing, which offers loan asset management services to other investors who want a piece of the action but don’t have their own infrastructure to manage it

ABR’s long-tenured and shareholder-aligned (12% insider ownership) management team has a solid track record of managing this complementary set of income streams – some floating and others fixed – while maintaining a strong balance sheet of mostly long-dated, non-recourse debt.

The typical balance sheet loan for ABR is a short-term bridge loan for a recently built or redeveloped multifamily complex that is in the lease-up phase. Once long-term financing can be obtained, the loan from ABR is repaid with the proceeds.

ABR’s structured loan book is 97% floating rate and should greatly benefit from rising interest rates. But ABR also has a record of strong performance through low interest rate environments, because it was able to increase the flow of loan originations.

Over 1-year, 3-year, 5-year, and 10-year periods, ABR’s total returns have absolutely crushed those of the broader mortgage REIT index (MORT):

With ABR gaining traction in the burgeoning build-to-rent single-family rental market, the mREIT appears poised to continue its long track record of outperformance while throwing off a well-covered 10.8%-yielding dividend.

I view ABR as an attractive holding for income investors and total return investors alike.

What Makes Arbor Realty Special

Unlike your average mortgage REIT that focuses either on owner-occupied residential mortgages and mortgage-backed securities or loans to a diversified mix of commercial property sectors, ABR specializes overwhelmingly in one commercial real estate sector: multifamily.

About 92% of the loans on its own book are for multifamily properties, with another 6% for single-family rentals.

Another thing I like about ABR’s loan book is its geographic concentration in fast-growing Sunbelt states; 48% of its balance sheet loans are located in Texas, Florida, Georgia, or North Carolina.

This loan book (loans originated by ABR and held on the balance sheet) makes up about 2/3rds of ABR’s total originations, with most of the remainder originated by government-sponsored agencies like Fannie Mae, Freddie Mac, and the Federal Housing Administration.

The nice thing about many of these originated but non-owned loans is that ABR earns fees for origination and often for ongoing servicing as well. In a way, ABR is an asset manager for federal government-sponsored agencies. This is probably the safest counterparty one can have.

As stated previously, the standard loan ABR originates and keeps on its balance sheet is a senior-level bridge loan collateralized by a multifamily property. (A bridge loan typically comes after a construction loan and before a mortgage or other long-term financing.) The initial term of these loans is 2-3 years plus about another 2 years’ worth of optional extensions.

As another point in ABR’s favor, the mREIT focuses on affordable workforce housing such as Class B apartments, which should suffer less through a recession.

ABR has grown its balance sheet loan book at an extremely rapid rate:

• 30% in 2019
• 28% in 2020
• 122% in 2021
• 23% in the first nine months of 2022

Given the large amount of multifamily housing under construction and set to be completed in the next few years, ABR should be able to continue this impressive growth rate for a little longer. But eventually, I would expect the growth rate to slow down.

ABR reported originations of $8.9 billion in the first nine months of 2022, compared to $16.1 billion for the full year of 2021.

Of course, ABR does not keep every loan it originates on its balance sheet. There are also the non-owned originations to keep in mind. ABR can still make money on these loans by originating them and then charging fees as an asset manager. This is a growing business as well.

In addition, ABR enjoys a few other auxiliary income streams such as escrow fees and equity investments.

With this business model, ABR has been generating some astoundingly strong returns on equity. In 2021, ROE averaged 19%. In the first nine months of 2022, ABR churned out an ROE of 17.7%.

Of course, ABR couldn’t generate an ROE like that without access to relatively low-cost debt. ABR typically pairs its floating rate loan assets with non-recourse, long-term floating rate debt, locking in an attractive spread whether interest rates move up or down.

Unsecured debt is typically locked in for multiple years at attractive rates. The nearest maturity is 2025.

ABR also ended Q3 2022 with around $600 million in total liquidity, and management believes the mREIT is well positioned to take advantage of any disruptions or opportunities offered by a 2023 recession.

Finally, another differentiator for ABR is the safety of the dividend.

In Q3 2022, ABR generated $0.56 in distributable EPS, compared to a (raised!) dividend of $0.40, making for a comfortable payout ratio of 71%.

This most recent dividend hike marked the 10th consecutive quarterly increase as well as the 10th year of consecutive annual increases.

Bottom Line

Don’t get me wrong. ABR’s leveraged loan business model is inherently higher risk than a standard equity or lending model. If even a handful of its loans default, perhaps in the case of the borrowers’ inability to refinance, the mREIT’s distributable earnings could take a big hit and severely erode the dividend coverage.

The risk of a 2023 recession triggering a negative chain reaction for ABR should not be ignored.

But ABR’s skilled, long-tenured, and shareholder-aligned management team have lots of experience navigating difficult periods, and they have expressed confidence in their capacity to take advantage of economic weakness with their $600 million in dry powder.