Ladder Capital: No. 1 Mortgage REIT Pick For 2023 (NYSE:LADR)

I certainly don’t consider myself an expert in underwriting commercial real estate loans, but I can provide some level of insight having borrowed my fair share of loans in my 30-plus year career in commercial real estate.

I’m especially knowledgeable with real estate finance having navigated through one of the most turbulent recessions in history. As I often tell my children, real estate investing seems fun… until you’re forced to make good on your personal guarantee.

Don’t get me wrong, fortunes can be made using leverage to own real estate, but as I found out in 2008, debt also can be painful if you’re not prepared.

Risk management is essential to any business model and especially when hard earned capital is at risk.

So, whenever I analyze a company, I always look hard at the managers who are running the business, always paying close attention to the sustainability of earnings.

Since the Great Recession, the mortgage REIT sector has evolved into a $25 billion (market cap) category dominated by some of the larger private equity firms such as Blackstone (BX), Starwood, KKR (KKR), TPG, and others.

During the Global Pandemic, when shares of many REITs were priced for bankruptcy, I was able to capitalize on names like Ladder Capital (NYSE:LADR) and Arbor Realty (ABR).

That was certainly an outlier period, as my strategy for owning shares in mREITs is for enhanced income.

Recognizing that mREITs are higher yielding than most equity REITs, I look to own the highest quality mREITs to “juice the yield” for my portfolio while also paying close attention to principal preservation. As you can see below, the average mREIT is yielding 12.4% with a P/E of 7.3x.

2022 was a tough year for these mREITs, as shown below. Interesting to see that these REITs gave back almost all of the gains from 2021:

Many of these mREITs have not experienced a recession yet as the industry grew as a result of the banking crisis. While many banks were going out of business, these mREITs were formed to take advantage of the void in the commercial real estate lending environment.

As seen above, commercial mREITs have returned an average of 17.2% since 2010, crushing residential mREITs by a wide margin. However, commercial mREITs were the worst performing REIT category in 2007-2009 – returning an average of -55% during this three-year period.

Have commercial mREITs learned the painful lessons from the Great Recession?

Enter Ladder…

Ladder is a commercial mREIT with $1.5 billion of book equity and $5.9 billion of assets across CRE (commercial real estate) loans, securities, and equity. Ladder shares many characteristics with traditional equity REITs, while delivering 2x–3x typical equity REIT dividend yields:

As you can see, there are other differentiators for the Ladder business model that includes internal management (unique to commercial mREITs), include ownership (insiders own ~10%), owned real estate (more on that later), and investment grade rating (rated Baa/BB with Moody’s and Fitch).

There are other unique attributes for this investment platform, so let’s take a closer look.

Senior Secured Lending

Ladder has a large asset base that consists of 48% of assets comprised of unencumbered assets and the mREIT is predominantly (63%) a senior-secured lender, with around $1.8 billion in assets:

One key differentiator for Ladder is its average loan size of around $20 million, with a focus on mid-market lending. Most of the peers focus on much larger deals, so these smaller loans provide Ladder with added diversification.

There’s always going to be a problem loan, but Ladder has an extremely loyal customer base – more than 50% of balance sheet loans to repeat borrowers.

Another advantage for the company is “flexibility to originate and manage multiple products.”

As you can see below, Ladder has a diversified lending platform, so it can easily deploy capital in the property sectors that offer the best risk-adjusted returns.

As seen above, Ladder has increased its multifamily exposure from 14% (in 2020) to 34% today. Also, hotel exposure has been reduced from 16% (in 2020) to around 4% today.

While Ladder does have office exposure, around 70% of post-COVID originations are in high growth markets.

The CMBS Segment

As I pointed out, Ladder’s primary business is originating senior secured loans, but the company also invests in short-date investment grade securities secured by senior real estate loans. The $611 million portfolio has an average CUSIP size of around $ 6.0 million and 99% of the loans are investment grade rated (86% AAA-rated or agency-backed).

The loans have a 12-year weighted average duration and are a source of liquidity given short duration and investment grade ratings. The highly-rated, liquid, short-duration portfolio of predominantly CMB has limited price volatility and only $177 million of securities repo debt is outstanding (4% of total debt outstanding).

Also, 82% of the loan portfolio is comprised of post-COVID originations and 72% of the loan portfolio growth has occurred since end of 2020. Ladder has originated $4.2 billion of new first mortgage loans since beginning of 2021 and here a few other key loan metrics:

The Net Lease and Other CRE Equity

Ladder is also unique to peers because the company acquires real estate with an emphasis on net lease properties. The company has a $1.0 billion portfolio (undepreciated asset value) of 6.1 million square feet and 166 properties. 65% of the portfolio is net leased with an average 10-year remaining lease term, with a focus on necessity-based businesses, such as BJ’s, Walgreens, and Dollar General.

The owned real estate properties provide Ladder with a source of stable, recurring net rental income with potential NAV upside, financed with long-term, non-recourse debt.

Drilling down to Ladder’s net lease portfolio (see below), we see value in the company spinning the assets into a net lease REIT – these assets generate $42.2 million of NOI (net operating income).

Also, we could envision a net lease REIT like Realty Income (O) acquiring these properties, that could generate around $300 million (non-recourse debt would have to be defeased).

The Disciplined Balance Sheet

Another differentiator for Ladder is its balance sheet with over $750 million of total liquidity, including $324 million fully undrawn corporate revolver. The company maintains a strong balance sheet with modest leverage and a high degree of financial flexibility afforded by a differentiated liability structure and large, high-quality unencumbered asset pool.

Approximately 50% of assets are fully unencumbered, and 75% of these assets are comprised of cash and senior secured first mortgage loans. Equity unsecured bonds and non-recourse non-mark-to-market debt make up 84% of the capital structure.

In Q3-22 Ladder extended and upside the revolving credit facility with its non-bank syndicate. This facility does not require a dedicated borrowing base unlike most other revolving credit facilities in the per group, which is a testament to the strength of the corporate credit.

Also, there are no bond maturities until 2025 with these strong credit ratios:

The combination of Ladder’s strong liquidity ($750 million) along with its large pool of unencumbered assets provides this mREIT with strong financial flexibility.

During Q3-22 Ladder repurchased $2.6 million of common stock at a weighted average price of $9.85 and YTD has repurchased $7.3 million of stock at a weighted average price of $10.09. Ladder also increased the authorization level of the share buyback program to $50 million.

Also, in Q3-22 Ladder declared a $0.23 per share dividend, a 5% increase from the Q2-22 dividend. Also, Ladder increased the dividend by 15% in 2022 and the current dividend yield is 9.2% – the lowest yield in the peer group (as shown below):

Follow the Money

In Q3-22 Ladder generated strong earnings:

And the dividend remains well covered:

Ladder is well positioned for rising rates with 89% floating rate loans. This large floating-rate balance sheet loan portfolio (predominantly fixed-rate liabilities) generates earnings that are positively correlated to rising interest rates (as shown below):

We always go the extra mile to seek alpha and we decided to compare Ladder’s dividend safety with the peers. The way we do this is to compare analyst growth estimates (using EPS) with the current dividends per share.

The takeaway from the above chart: Ladder’s current dividend and future dividend appear to be on sound footing. Take a look at Ladder’s consensus growth estimates for 2023 and 2024:

That chart illustrates 11% growth in 2023 and 10% growth in 2024.

This suggests that Ladder will see robust dividend growth this year and next…

The safest dividend is the one that’s just been raised…

Once again, Ladder’s management team recognizes the importance of shareholder alignment:

Ladder has historically traded at ~10,9x P/E and is now trading at 8.8x, as shown below:

As seen below, we modeled a future 12-month multiple of 9.0x and this translates into a conservative (12-month) total return estimate of 23%:

Our realistic model has Ladder returning ~40% in 12 months:

As you’ve heard me say before, “management matters” and we’re most bullish because of the fully aligned management team where the executive team averages 26 years of industry experience. The majority of the management team has worked together for over 25 years.

At the end of the day (and to quote Howard Marks), “managing risk is what separates the best from the rest.” Pound-for-pound we consider Ladder one of the best-oiled machines in the REIT sector and this name is our No. 1 mREIT pick in 2023.