Investment Thesis
Franklin BSP Realty Trust (NYSE:FBRT) is a name that popped up on my radar as being potentially undervalued. At 7.7x FWD earnings and .81x book value, the stock looked cheap compared to the value it holds in my view. Investors may be scared that the company owns a lot of CRE debt, but I think that fear is already more than priced in. Furthermore, I feel that management has handled this risk well by positioning their portfolio carefully with floating interest rates and mainly focusing on multi-family, not office. In conclusion, I rate shares of FBRT as a buy due to its strong liquidity and high dividend yield at a cheap price.
Company Overview
FBRT is a mREIT that “originates, acquires and manages a diversified portfolio of commercial real estate debt secured by properties located in the United States” according to their website. Unlike other mREITs, Franklin BSP is focused on lending money specifically to commercial real estate, building a “diversified portfolio of senior, floating rate loans”.
According to the recent 10-Q, “The commercial mortgage loans, held for investment, net of allowance for credit losses, as of March 31, 2024 and December 31, 2023 had a total carrying value of $5,184.2 million and $4,989.8 million, respectively”. The average carrying value per loan by my calculations is $35.75 million, if we divide $5.185 billion by 145 total loans. Investors can see that the portfolio is well-diversified and has seen a slight increase of 3.9% compared to last quarter.
The portfolio consists of loans that are mainly floating, with 96.5% of loans being reported as floating rate type as of March 31, 2024. With a weighted average coupon of 9.2%, investors can see that floating rate loans have been a nice benefit to have when rates rise. Finally, most of the loans have a short maturity of 1 year, so interest rate movements actually do not hugely impact the loan value that much due to shorter duration.
I am very surprised that management has positioned their portfolio strategically, with high coupons, low duration, and mostly floating rate loans. The market seems to be underpricing the strength of the portfolio because it seems very resilient to interest rate changes, has a high yield, and management has a lot of flexibility to redeploy capital due to strong liquidity in my view.
Liquidity and debt levels are very healthy, with the presentation indicating “$1.0 billion of liquidity of which $240 million in cash” and “net debt to equity ratio of 2.4x”. My belief is that management is prepared to redeploy capital and building up this dry powder to buy loans at distressed prices from the commercial real estate sector. This should enhance shareholder value and I expect the earnings to continue to be able to cover the dividend. Ultimately, this is one of the strongest commercial mREITs out there on the market in my opinion due to the strong liquidity, healthy leverage, and low-duration loan portfolio that the company has.
Earnings Grow Steadily
The company announced earnings for Q1 2024 with the following results,
- Produced a first quarter GAAP and Distributable Earnings ROE (a non-GAAP financial measure) of 8.9% and 10.4%, respectively
- Book value of $15.68 per diluted common share on a fully converted basis
- Declared first quarter common stock cash dividend of $0.355, representing an annualized 9.1% yield on book value per share, fully converted
Earnings continue to grow steadily as their multi-family focused portfolio continues to perform very well. I believe this earnings report demonstrates the strength of their loan portfolio and that they can perform well under inflationary pressures and higher rates. Furthermore, the dividend is still well-covered as the earnings transcript revealed that “our distributable earnings dividend coverage for the quarter was a 115%”.
The company seems to be in an offensive position with an aggressive liquidity position that enables them to originate a healthy amount of loans to grow. In their earnings call they explain,
We have been actively originating loans, and have committed to $756 million of originations year-to-date. This has fueled net growth in our portfolio.
I believe that this net growth in the portfolio will continue as long as liquidity and debt levels remain strong. So, the book value here may actually start to grow, reaching $16 per share and beyond as the originations continue. Management can also increase book value per share with buybacks, as they “repurchased 151,123 shares of common stock at a net average price of $12.42 per share for an aggregate of $1.9 million,” according to the quarter’s press release.
With an aggressive liquidity position, buybacks, and distributable earnings dividend coverage of 115%, there’s a lot to like here for investors. The market has not fully priced in these positive developments in my view and the gap between price and book value should close over time. This quarter’s earnings reinforces the bull case for Franklin BSP as it highlights the strength of the loan portfolio, growing earnings, and a potentially growing book value going forward.
Multi-Family Focus Protects Investors
Companies that focus on lending money against multi-family properties are well protected by inflation and challenges in the CRE space in my view. This is because people have to live someplace, and as buying a home outright has become increasingly unaffordable many people are turning to renting spaces in multi-family properties to live.
According to the National Association of Home Builders, “NAHB has updated its housing affordability graph for 2024, and the latest data show that 66.6 million households, 49% out of a total of 134.9 million, are unable to afford a $250,000 home”.
What this means in my opinion for Franklin BSP investors is that their multi-family focus is more attractive as more people have to make do with renting apartments and living in condos in today’s housing market. Therefore, the loan performance of multi-family should continue to remain strong as growing demand bids up the prices of rents, giving borrowers stronger capability to pay off debts they owe to Franklin BSP.
Furthermore, I see increased distress and carnage in the CRE space to be an opportunity for Franklin BSP because they have so much dry powder ready to deploy, and many of their loans are getting close to maturity. Many borrowers that have taken out loans to purchase office buildings are suffering badly today, and I suspect that many of these distressed office loans will soon hit the secondary market at fire-sale prices.
I believe that many of these loans can be bought by Franklin BSP at very low levels that may actually enhance shareholder value, if done properly. Therefore, investors can see that trouble can turn into opportunity and Franklin BSP has the balance sheet, liquidity, and management team to make the best use of this CRE debt crisis in my view.
Valuation – $15 Fair Value
The stock should trade at book value in my opinion, given the strength and performance of the loan portfolio. Book value per share was around $15 for the quarter, so I am setting my price target there. I believe book value is a fair indication of the true value of the business because the loans are well-performing, high-yield, and low duration which makes them attractive to me in today’s market environment.
At 7x FWD earnings, it trades at a discount to the sector median of 10x FWD earnings which demonstrates to me the stock is mis-priced. I feel that the strength of the loan portfolio and management quality should deserve at least a sector median multiple, so if we apply a 10x multiple to $1.50 EPS that also reaffirms my $15 price target. I think $1.50 EPS should be sustainable from here on out because the company has demonstrated an aggressive stance in originating loans and growing their portfolio.
The dividend should be protected as earnings more than cover the payout. With an 11% FWD dividend yield, income investors may find their payouts attractive. Going forward, I believe that their distributable earnings dividend coverage will continue to be over 100% given the strong track record of their loan portfolio performance.
Risks
Past dividend coverage is no guarantee of future dividend coverage. If management decides they want to increase liquidity, they may decide to cut the dividend and redeploy the capital into the market to buy/originate attractive loans for the portfolio. Also, an decrease in rates may hurt Franklin BSP because their loans are floating rate, and the interest they earn can drop as a result. However, it should be noted that this risk is relatively small because most of their loans are short-term duration.
If inflation and the job market get really weak, it’s possible that multi-family performance could sour. Rent may get out of reach for the average person and it could harm Franklin BSP’s multi-family loan performance. Furthermore, some of their office loans could default as the entire sector continues to show weakness in occupancy rates.
Improvements in the housing market in terms of affordability could reverse the bullish trend for multi-family, as people move out of apartments and into homes. Furthermore, government regulations that try to make rents more affordable could negatively impact loan performance as rent ceilings and such limit the amount of cash flow borrowers earn to pay off their debts.
Buy Franklin BSP Realty
While fear and uncertainty plague the CRE sector in my view, I see Franklin BSP Realty as one of the few commercial mREITs well positioned to take advantage of this distress. It stood out as being resilient to interest rate volatility, protected from CRE headwinds due to its multi-family focus, and has a well-covered high dividend yield. Thus, I recommend investors who look high dividend yielding stocks to consider buying Franklin BSP Realty.
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