A REIT With 6% Yield Looks Enticing

 | Jun 11, 2013 | 10:00 AM EDT  | Comments
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The recent rise in interest rates has had a negative impact on shares of high-yield instruments such as dividend stocks in traditional income paying sectors like utilities over the last month.

Bond mutual funds also had their biggest weekly outflows ($12.53 billion) on record for the week ending June 5. The rate backup has taken its toll on corporate high-yield bond funds as well as a myriad of different high-income real estate investment trusts. I decided to peruse these sectors to see if I could find any solid high-yielding entities that might be worth an investment after this selloff. One unique commercial REIT caught my eye, RAIT Financial Trust (RAS). This interesting, multifaceted commercial real estate company has sold off 10% recently and now offers an over 6% yield.

Company Overview

RAIT Financial Trust is a multi-strategy commercial real estate company incorporated as a real estate investment trust. The company operates in three core areas. It originates commercial real estate loans, purchases commercial real estate properties and invests in commercial mortgage backed securities.

Revenue from these ventures comes from three avenues: (1) Fee income from originating servicing and securitizing commercial loans; (2) Rental income from the real estate properties owned; (3) Revenues from interest income on its CMBS portfolio.

The company has $3.7 billion in assets under management including approximately $1 billion worth of well-diversified real estate assets. RAIT Financial Trust's approach to manage all three parts of its business is outlined at a high level below.

Stock History

Like most commercial and real estate mortgage REITs, RAIT Financial Trust had a near-death experience in the financial crisis as liquidity dried up completely. After bouncing off its nadir, however, the stock has moved up nicely through a seesaw pattern. It was in the middle of another good move up before rising interest rates initiated a 10% decline which presents a nice buying opportunity. RAS is way below its pre-crisis highs (See Chart).

Dividend & Operating Income Growth

The key to the company's solid stock performance over the last two years has been its consistently rising operating income and dividend payouts (See Chart). Payouts have doubled over the past two years and RAS now yields over six percent (6.2%).

Based on the company's recently reported quarter, this performance appears looks as if it is set to continue for the immediate future. Among other highlights, RAS reported:

  • Earnings adjusted funds from operations was up 47% year-on-year.
  • Overall revenues came in at $58 million, up 27% year-on-year.
  • Rental income was up 9% to $27 million, with effective rent per unit up 4%.

Business Outlook & Valuation

About $1.5 trillion worth of commercial real estate debt is expected to mature from now until 2018. RAS has limited competition for the small balance conduit loans (typical size $5 million to $30 million) and the short-term transitional loans it specializes in making and it offers a one stop financial option to its niche customers. Its loan portfolio is well diversified by property type and geographical region.

The company also collects management fees for managing approximately $2 billion of commercial real estate loans and $1.6 billion of U.S. real estate debt securities. Finally, RAS owns $1 billion worth of commercial real estate that is also well diversified by geographical region and also tilted towards multi-family properties (60% of net asset value) which should lessen the overall volatility in the portfolio.

I

Despite a yield of 6.2%, RAS is selling for 5.5x this year's expected earnings and a little over its adjusted book value per share. Analysts expect the company to grow revenues at better than a 10% compound annual growth rate over the next two fiscal years. As long as the commercial real estate market continues to be solid and rates do not have a major hike up from current levels, RAS should be able to provide both income and growth to shareholders over the next few years.

I have used the opportunity of the recent pull back in high income instruments over the last few weeks to start to build a position is this multi-faceted and well-diversified REIT.

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