Seven Hills Realty Trust Q1 2024 Earnings Call Transcript

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Provided by Quartr
April 30, 2024

Key Takeaways

  • Positive Sentiment: Q1 distributable earnings per share of $0.38 exceeded guidance by 9%, covering the $0.35 dividend by 109% and delivering total shareholder returns 7 percentage points above the NAREIT benchmark.
  • Positive Sentiment: The loan portfolio maintains a stable credit profile with an average risk rating of 3, no non-accrual or default loans, and a modest 1% CECL reserve on total commitments.
  • Positive Sentiment: While no new Q1 originations closed, the company has over $600 million in active pipeline and post-quarter closed a $17.8 million multifamily loan at a 9% all-in yield.
  • Neutral Sentiment: Portfolio diversification continues with office exposure reduced to 28% from 40% a year ago and multifamily now the largest sector at 35%.
  • Negative Sentiment: Higher-for-longer interest rate expectations and competitive spread compression are weighing on refinance activity and may slow loan closing velocity.
AI Generated. May Contain Errors.
Earnings Conference Call
Seven Hills Realty Trust Q1 2024
00:00 / 00:00

There are 6 speakers on the call.

Operator

Good morning, and welcome to the Seven Hills Realty Trust First Quarter 2024 Financial Results Conference Call. All participants will be in listen only mode. Call. Please note, this event is being recorded. I would now like to turn the call over to Stephen Colbert, Director of Investor Relations.

Operator

Please go ahead.

Speaker 1

Good morning. Joining me on today's call are Tom Lorenzini, President and Chief Investment Officer and Fernando Diaz, Chief Financial Officer and Treasurer. Today's call includes a presentation by management, followed by a question and answer session with analysts. Please note that the recording, retransmission and transcription of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws.

Speaker 1

These forward looking statements are based on 7 Hill's beliefs and expectations as of today, April 30, 2024, and actual results may differ materially from those that we project. The company undertakes no obligation revise or publicly release the results of any revision to the forward looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from the SEC's website. Investors are cautioned not to place undue reliance upon any forward looking statements. In addition, we will be discussing non GAAP financial numbers during this call, including distributable earnings and distributable earnings per share.

Speaker 1

A reconciliation of GAAP to non GAAP financial measures can be found in our earnings release presentation, which can be found on our website atsevnreit.com. And with that, I will turn the call over to Tom.

Speaker 2

Thanks, Stephen. Good morning, everyone, and thank you for joining our call today. Last night, we reported strong first quarter results highlighted by distributable earnings per share that were above the high end of our guidance range. The continued strength and stability of Southern Hills investment portfolio once again helped to deliver positive total shareholder returns that exceeded our NAREIT industry benchmark for the quarter. We believe this ongoing outperformance serves as a testament to the strength of our loan book and our disciplined underwriting originations and asset management teams.

Speaker 2

With ample liquidity on hand, we look forward to continuing to build on our momentum throughout 2024. Turning to a few highlights from the Q1. We delivered distributable earnings per share of $0.38 exceeding our $0.35 per share quarterly dividend by 9%. The credit profile of our loan portfolio remains stable with an overall average risk rating of 3 with no loans in default and no non accrual loans. We received over $40,000,000 of loan payoffs demonstrating the continued ability of our well capitalized sponsors to execute on their business plans in today's market.

Speaker 2

And we delivered total shareholder return that outperformed the industry benchmark by more than 7 percentage points equating to cumulative outperformance of more than 60% since the beginning of 2022. From a macro perspective, the U. S. Economy has remained resilient amid a backdrop of relatively strong economic data and inflation readings above the Federal Reserve's comfort level. As a result, expectations for interest rate cuts have shifted and are now weighted towards the back half of this year.

Speaker 2

While we believe that lower interest rates will ultimately create a more favorable environment for real estate transactions and result in increased lending opportunities, we are confident in our current production pipeline to provide a steady flow of attractive investment opportunities to further expand our loan book this year.

Speaker 3

Turning to

Speaker 2

our Q1 portfolio activity. Our conservatively underwritten portfolio continues to experience repayments across various property types. During the quarter, we received 3 loan payoffs including 1 office, 1 retail and 1 industrial property for a total of $40,400,000 We did not close on any new loans during the Q1, which is traditionally a slower period of the year. Post quarter end, however, on April 25, we closed a multi family loan with a total commitment of $17,800,000 with a coupon of sulfur of 315 basis points for an all in yield of 9% when including loan fees. Turning to our loan book as of March 31, 7 Health portfolio remained 100 percent invested in floating rate loans and consisted of 21 first mortgages with an average loan size of $30,000,000 and total commitments of nearly $630,000,000 down approximately 6% or $40,000,000 from last quarter.

Speaker 2

While future fundings remain consistent at only about 6% of our total commitments. Our investments have a weighted average coupon 9.1 percent and an all in yield of 9.6%. In aggregate, the portfolio has a weighted average maximum maturity of 2.8 years including extension options and a stable overall credit profile with an average risk rating of 3 and a loan to value at close of 68%. We continue to make progress diversifying our loan book. As of quarter end, multifamily was our largest property type at 35%.

Speaker 2

Our office exposure has declined to 28% compared to 40% a year ago. The balance of our portfolio is comprised of retail, hospitality, self storage and industrial loans. In terms of portfolio vintage, after the repayments we received during the Q1, Seven Hills portfolio now consisted entirely of loans that were originated subsequent to the onset of the pandemic. From a capital perspective, our lending partners remain very supportive of our business. In aggregate, our 4 secured financing facilities provided us with nearly $700,000,000 in borrowing sulfur plus 2 18 basis points at the end of the quarter.

Speaker 2

Turning to our active deal pipeline. We continue to see a steady flow of deals with over $600,000,000 of prospective lending opportunities in various stages of our screening and diligence process, consisting of acquisition and refinancing requests for industrial, multifamily, self storage, retail and hospitality properties, including one loan for $23,800,000 currently under application and in diligence and expected to close within the next 45 days. In closing, our portfolio and overall credit performance remains strong and our business continues to deliver solid results. While interest rates are likely to remain higher for longer, we believe we are well positioned to accelerate loan production this year, selecting the most compelling investment opportunities for our portfolio and continue to generate attractive returns for our shareholders. With that, I will now turn the call over to Fernando.

Speaker 3

Thank you, Tom, and good morning. Yesterday afternoon, we reported Q1 2024 distributable earnings or DE of $5,600,000 or $0.38 per share, which was $0.01 above the high end of our guidance range, primarily due to the timing of loan repayments during the quarter. Our run rate earnings over the last few quarters have comfortably exceeded our dividend level. In mid April, we declared our regular quarterly dividend to shareholders of $0.35 per share payable on May 16th, which our Q1 DE covered by approximately 109%. On an annualized basis, our dividend equates to a yield of approximately 11% based on yesterday's closing stock price.

Speaker 3

Our CECL reserve remains modest at 100 basis points of our total loan commitments as of March 31 and all loans remain current on debt service and we have no non accrual loans. We remain focused on further diversifying our portfolio into real estate sectors with fundamentals we deem to be more attractive and have reduced our office exposure to 28% as of quarter end compared to 40% in the Q1 of 2023. The reminder, to help protect us against investment losses, we structure all of our loans with risk mitigation mechanisms such as cash flow sweeps, interest reserves and rebalancing requirements. And we do not have any collateral dependent loans or loans with specific reserves. In the Q1, Seven Hills maintained its conservative leverage metrics and continues to have substantial liquidity.

Speaker 3

We ended the quarter with $93,000,000 of cash on hand and $272,000,000 of reinvestment capacity across our 4 secured financing facilities. Total debt to equity decreased to 1.6 times from 1.7 times at the end of the previous quarter, primarily due to the 3 loan repayments that Tom discussed. We believe that our conservative leverage and available borrowing capacity provide a strong opportunity to originate accretive loans that will benefit the company going forward. Turning to our outlook and guidance for the Q2. We expect distributable earnings to be within a range of $0.35 to $0.37 per share, which will continue to cover our quarterly dividend.

Speaker 3

This guidance reflects our recent origination and repayment activity and assumes flat G and A expenses and that interest rates will remain consistent with current levels. That concludes our prepared remarks. And with that operator, please open the lines

Speaker 4

for questions.

Operator

Thank you. We will now begin the question and answer session. The first question comes from Matthew Erner with Jones Trading. Please go ahead.

Speaker 5

Hey, good morning guys. Thanks for taking the question. Could you talk a little bit about the pipeline and what you guys are really looking forward to accelerate that loan growth whether it be specific property types, geographic regions? And I guess how quickly do you think that you can scale up the portfolio to an optimal size?

Speaker 2

Thanks for the call. It's Tom here. So from a geographic region, certainly we run nationwide as you're aware. There's really and that continues to be the focus, right. So we have not up redlined any particular markets that we're going to lend into.

Speaker 2

From a product standpoint, I would tell you that we're still very active in the multifamily sector. As I noted, we just closed the multifamily loan. We currently have under application right now and in diligence, a self storage property that we're looking at on the West Coast. We expect that to close in the next 45 days or so. Industrial still makes sense in certain locations and hospitality, we're seeing hospitality perform very well right now and we're looking at a few opportunities there as well.

Speaker 2

What we've modeled for production is about $175,000,000 of loans for the year. I think we're projected to do 6 loans at about $28,000,000 to $30,000,000 apiece. And then from there, we could increase that depending on the velocity of repayments that we have. We do expect a couple of repayments in the before the end of the year yet. So maybe there's another $50,000,000 to $80,000,000 that comes back that we can reinvest.

Speaker 2

But we see no reason why we can't hit our target right now of the 6 loans for the year of 'twenty four.

Speaker 5

Awesome. Thank you for that. That's good color there. And then I noticed a couple of the occupancies on the office, particularly the one in Dallas ticked up to 73% from 67% quarter over quarter. Could you talk about what you're seeing when in leasing in your guys' properties and then just the overall market there?

Speaker 2

Yes. So the Dallas transaction, they were they did have some modest uptick in leasing there. They actually changed their leasing team there as well, which has generated additional foot traffic and additional tours of the property. As far as what we're seeing in leasing for the one asset that we own the floral rail transaction that you're aware of in Yardena, Pennsylvania, We've seen some good positive leasing momentum there as well. We've had numerous tours for our leasing brokers there And we're looking at currently under an LOI for a modest increase in occupancy there with a new tenant that's moving into the space.

Speaker 2

So overall, office is difficult as you're aware. I think it really depends on the leasing team that you have there and that if you have capitalized sponsors that are willing to contribute the cash necessary to the TI spend and the commission spend, right, to attract those new tenants. So we are cautiously optimistic, I would say, on the on our other portfolio. Everybody is current on debt service. All the loans are have available cash as needed for TIs and leasing and for carry, if that's the case.

Speaker 5

Yes. Well, that's great news. Thanks for answering the questions.

Speaker 2

Thank

Operator

The next question comes from Chris Mueller with Citizens JMP. Please go ahead.

Speaker 4

Hey guys, thanks for taking the questions. So I want to hit on the pipeline a little bit as well. So I think on the last call you said there was like $750,000,000 in the pipeline there. Can you talk about kind of the dynamics that are playing out there? Are loans falling out of the pipeline before reaching the finish line?

Speaker 4

Or the finish line or you guys just not seeing loans you like there or just maybe building some defensive or even opportunistic capital right now? Thanks.

Speaker 2

Yes, Chris, I think it's a little bit of all of those things that you just mentioned. There's been going back a few months, right, I think the optimism in the market was, hey, the Fed is going to lower rates. Maybe now is the time I can entertain a refinance from an existing borrower, get off my current loan, maybe ride the curve down and put some better financing in place. So a good number of those transactions didn't happen, right, because the messaging coming from the Fed and the economy in general is just that, hey, look, we're going to be at a higher interest rate period for a longer time. So I think it took a little bit of a wind out of sales, if you will, for quite a few people that might have been looking to refinance.

Speaker 2

The other thing that we're seeing, there's still in the market, you have over leverage transactions that were written in 2021 maybe that are coming due, especially in the multifamily sector where we're trying to be active, which are going to require some cash in. So we'll often underwrite transactions that we want to go after and there may be some cash required from the sponsorship to balance that out and they're not willing to do that. So that transaction doesn't happen. The other dynamic that you have going on is there's just a lot of dry powder, I think on the sidelines with a lot of lenders. So when you find a transaction that works, it's very competitive.

Speaker 2

And we've seen spread compression. So we may find ourselves in situations where we certainly want the transaction, we're putting best foot forward and somebody really just kind of comes in and almost buys the business, if you will, because they might be feeding the CLO or some other securitized execution and they're willing to do it much cheaper than we feel is appropriate. So there is flow out there. It's just a little more difficult to get it across the goal line right now.

Speaker 4

Got it. That's very helpful. And then changing gears a little bit here. So it looks like the purchase accretion discount should run out in the next maybe quarter or 2. It looks like that added about $0.08 to revenues in the Q1 here.

Speaker 4

So I guess my question is, do you expect GAAP earnings to run below the dividend level in the near term and we'll see some book value decline as a result of that?

Speaker 3

Chris, this is Fernando. I'll take that. We are expecting this accretion to run off by the 3rd quarter. So it will be progressive. Q2 and Q3 will be done like I said.

Speaker 3

So we don't believe that's going to be impacting that much in terms of the earnings. Obviously, as we ramp up our production as Tom alluded, that's going to help us balance that as well.

Speaker 4

That's helpful. Thanks for taking the question.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Tom Lorenzini for any closing remarks.

Speaker 2

Thanks everyone for joining us today. We look to seeing many of you at the NAREIT conference in New York City in June. Operator, this concludes our call today.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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