Seven Hills Realty Trust Q1 2025 Earnings Call Transcript

Quartr
Provided by Quartr
April 29, 2025

There are 7 speakers on the call.

Operator

Good morning, and welcome to Seven Hills Realty Trust First Quarter twenty twenty five Financial Results Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the call over to Matt Murphy, Manager of Investor Relations. Please go ahead.

Speaker 1

Good morning. Joining me on today's call are Tom Lorenzini, President and Chief Investment Officer Matt Brown, Chief Financial Officer and Treasurer and Jared Lewis, Vice President. 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 Seven Hills beliefs and expectations as of today, 04/29/2025 and actual results may differ materially from those that we project. The company undertakes no obligation to 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 at 7reit.com. With that, I will now turn the call over to Tom.

Speaker 2

Thank you, Matt, and good morning, everyone. On today's call, I will begin with an overview of our first quarter performance and portfolio positioning followed by some thoughts on the evolving rate environment and how it is impacting our outlook. Will then turn the call over to Jared to discuss our pipeline and broader market conditions, after which we will hear from Matt Brown, who I'm happy to introduce as our new Chief Financial Officer and Treasurer. Matt currently serves as a Senior Vice President at the RMR Group and brings nearly twenty years of accounting and commercial real estate finance experience to the team. Matt will review our financial results before we open the line for questions.

Speaker 2

For the first quarter, we reported distributable earnings of $0.34 per share exceeding the high end of our guidance range. These results reflect the continued strength and ongoing performance of our loan portfolio supported by new loan production that help mitigate the impact of lower interest rates on our loan book. We also declared and paid a quarterly dividend of $0.35 per share. As of March 31, all loans in our portfolio remained current and performing with no non accrual loans. Our weighted average risk rating improved to 2.9 down from 3.1 last quarter.

Speaker 2

This improvement coupled with the fact that we have no loans in default reinforces the strong health of our portfolio and our borrowers' ability to execute on their business plans. As of quarter end, our portfolio totaled $691,000,000 in commitments comprised of twenty three first mortgage loans with a weighted average all in yield of 8.5%, a weighted average coupon of SOFR plus 3.69 and a weighted average loan to value of 67% at close. The portfolio had a weighted average maximum maturity of two point six years when including extension options and an average loan size of approximately $30,000,000 We ended the quarter with approximately 42,000,000 in cash and $298,000,000 in unused financing capacity providing us with significant flexibility as we evaluate new investment opportunities. During the quarter, we closed two new student housing loans totaling approximately $50,000,000 a $31,200,000 loan in San Marcos, Texas and an $18,500,000 loan in Waco, Texas. Both loans are secured by well located university adjacent assets with experienced sponsors.

Speaker 2

These investments align with our focus on resilient sectors and disciplined credit selection, particularly in student housing where we continue to see durable demand drivers and well capitalized sponsors. Office exposure has declined to 25% of the portfolio in the first quarter, down from 27% at year end. While all our office loans remain current and supported by committed sponsors, we continue to actively reduce exposure to this sector in favor of asset classes such as multifamily, student housing, industrial and necessity based retail, which we believe offer stronger fundamentals and greater durability through various economic cycles. While our floating rate portfolio has benefited from elevated interest rates over the past several quarters, we acknowledge that a lower rate environment going forward combined with anticipated repayments could put pressure on earnings over the balance of the year. In particular, several of the loans we expect to be repaid at 2025 were originated at spreads above today's market pricing.

Speaker 2

And as those proceeds are redeployed, we anticipate a more normalized earnings profile to emerge. However, it is important to note that the timing and nature of redeployment activity may influence how this transition plays out. From our perspective, there are three key factors that will influence earnings throughout the balance of the year. First, the direction of interest rates. Any movement from the Fed will impact our whole loan returns and proportionately our borrowing costs.

Speaker 2

So this is something we're watching closely. Second, the pace at which we're able to originate new loans. We're seeing good pipeline activity, but timing can vary and competitive dynamics are influencing how those opportunities are being priced. And third, our ability to structure deals that meet our underwriting standards and still deliver attractive risk adjusted returns. While these variables remain largely market driven, there are also factors within our control that may help offset earnings pressure.

Speaker 2

We have capacity to deploy capital efficiently and as volatility causes some lenders to pause, we are beginning to see increased opportunities to originate high quality loans at favorable pricing. Our business model is well positioned to respond to shifting market conditions and our disciplined credit approach continues to earn the trust of sponsors seeking reliable execution. To summarize, while the environment remains uncertain, it is important to note that our more cautious outlook reflects the macro backdrop and not a deterioration in our portfolio's quality. Our loans remain fully performing supported by stable property fundamentals and an improved risk profile. We remain confident that our selective approach, strong sponsor relationships and current liquidity position us to navigate this evolving landscape and capitalize on opportunities as they arise.

Speaker 2

With that, I will now turn the call over to Jared for an overview of our pipeline and further insights into the current macro environment.

Speaker 1

Thanks, Tom. For the third quarter in a row, we saw market participants, borrowers and lenders alike operate with a renewed sense of optimism. With seemingly greater clarity on the path of interest rates early in the quarter and increased competition amongst lenders for new loans, borrowers were able to make financing decisions with greater conviction. Our pipeline remained robust during the quarter and we noticed an uptick in requests for new acquisitions, further signaling an improvement in overall market conditions. Over the past several weeks, however, we have seen a bit of shift in market sentiment.

Speaker 1

After significant spread tightening early in the quarter driven by strong secondary market demand, particularly in the CRE CLO CMBS sectors, we are starting to see signs of spreads widening caused in part by recent tariff related headlines and uncertainties surrounding the Fed's rate path. While certain inflation figures have moved lower, the potential for tariffs to introduce new cost pressures has created a two way scenario. On the one hand, slowing growth could prompt rate cuts, while on the other hand, potential tariff driven inflation could create enough uncertainty to delay them. Despite the capital market volatility, this still exists to get a significant amount of 2021 and 2022 vintage loans scheduled to mature over the year, which will need to be addressed. Given these dynamics, we continue to see significant financing demand for floating rate loans to refinance both bridge and construction debt that still need time for business plans to play out and properties to stabilize.

Speaker 1

In terms of property types, we continue to see strength in the multifamily sector where the combination of elevated homeownership costs, limited new supply and stable demand drivers continue to benefit the performance of existing assets. We are also selectively pursuing industrial loans in markets with strong fundamentals, including a $28,000,000 loan currently in diligence in the San Antonio area that we expect to close next month. This loan is secured by a newly constructed Class A distribution facility that includes a conservative reserve structure and lease up assumptions. We also continue to evaluate retail and hospitality on a case by case basis. While these sectors carry more macro sensitivity, we believe necessity based retail and select hospitality transactions can offer compelling risk adjusted returns, particularly those with strong in place cash flows, multiple demand drivers and conservative loan structures.

Speaker 1

That said, while the lending markets remain active, particularly in the multifamily and industrial sectors, we have also started to see some lenders take pause waiting for capital market volatility to subside. We view this as an opportunity especially given our clean balance sheet and available borrowing capacity. To that end, we are evaluating a number of opportunities and remain focused on disciplined credit selection with an emphasis on well capitalized sponsors and markets that continue to demonstrate strong underlying fundamentals. We believe our selective approach positions us well to take advantage of dislocations as they arise. With that, I'll turn the call over to Matt Brown for a review of our financial results.

Speaker 3

Thank you, Jared, and good morning, everyone. Yesterday, we reported first quarter distributable earnings of $5,000,000 or $0.34 per share, exceeding our guidance range for the quarter. The beat to guidance was driven by net earnings from loans and the revenue from the one property that we own. Earlier this month, we declared a quarterly dividend of $0.35 per share. Our CECL reserve remains modest at 130 basis points of our total loan commitments as of March 31 compared to 140 basis points as of December 31.

Speaker 3

The $153,000 reserve reversal was primarily due to improved performance at certain of the collateral assets underlying our loans. We do not have any collateral dependent loans or loans with specific reserves. We ended the quarter with $42,000,000 of cash on hand and a weighted average borrowing rate of SOFR plus two twenty one basis points. Total debt to equity remained at 1.6 times. We believe that our conservative leverage and available borrowing capacity provide us with a strong opportunity to originate accretive loans.

Speaker 3

Turning to our outlook and guidance. While our loan portfolio continues to perform supported by an improvement to our conservative overall risk rating of 2.9, declining benchmark interest rates and compressed net interest margins on loan originations could put pressure on earnings as certain of our older vintage loans with higher net interest margins are expected to be repaid this year. As such, our Board of Trustees will continue to evaluate our dividend rate to ensure it is at a sustainable level. Based on current expectations for loan originations and repayments, including loan repayments that may exceed originations during the quarter, we expect second quarter distributable earnings to be in the range of $0.29 to $0.31 per share. As Tom and Jared discussed, we have a robust pipeline, including a $28,000,000 loan currently in diligence that we expect to close later in the second quarter.

Speaker 3

Before turning the call over to questions, I want to highlight that we have added three new slides to our earnings presentation to further illustrate our earnings trends from Q4 to Q1 as well as trends in net interest rate spreads and leverage. These new slides can be found on Pages six to eight in our earnings presentation. That concludes our prepared remarks. Operator, please open the line for questions.

Operator

The first question comes from Jason Weaver with Jones Trading. Please go ahead.

Speaker 4

Hi, guys. Good morning. Thanks for taking my question. I know we've discussed the tightness in originations before making this less of

Speaker 5

an issue, but can

Speaker 4

you comment on any discussions with your lenders, how they've gone thus far? Any sense of trepidation there all the way into April?

Speaker 1

Hi, Jason. This is Jared. So we've had great conversations with our lenders. They've all been pretty supportive of our business. We've evaluated a lot of new opportunities over the quarter and they've we work closely with them to evaluate each opportunity.

Speaker 1

And so they've been really helpful in helping us price credit. So we haven't seen a lot of movement from them. We are hearing that market spreads and secondary market spreads are widening a little bit, but to the extent that we've been able to hold our borrowing costs steady, they've been pretty supportive of doing that.

Speaker 4

Got it. And that all in borrowing cost of S plus, I think you said $269,000,000 has that remained relatively consistent into to date?

Speaker 1

No. Of late that reflects the overall the overarching portfolio. But of late, we've seen borrowing costs come commensurate with where spreads were in the first quarter. So we're targeting and underwriting borrowing costs somewhere in the sulfur plus 2% range.

Speaker 4

Got it. And if I could just do one more, maybe for Tom. You mentioned earnings depending on your ability to originate within your own underwriting standards. Can you speak a bit more to that? Are you modifying your underwriting approach in any material way?

Speaker 2

No. We are not modifying our approach. The comment really refers to in the first quarter things got pretty heated from a competitive standpoint and it's really about maintaining the credit underwriting and what we've been doing historically not into weaker credit underwriting standards.

Speaker 4

Got it. Thanks for that clarification. Better than just blindly pursuing market share. Okay. Well, that's been very helpful.

Speaker 4

Thank you, guys.

Speaker 2

Thank you.

Operator

Our next question comes from Chris Moeller with Citizens Capital Markets. Please go ahead.

Speaker 5

Hey, guys. Thanks for taking my questions and congrats on a nice start to 2025. So I wanted to start on credit. You guys have had great credit performance across the portfolio even with a good chunk of the portfolio in office loans. So I guess is there anything that you can point to that success?

Speaker 5

Is it your strict underwriting standards or geographies or loan sizings or even the type of borrowers you work with? Just anything that would help us drill down there I think would be helpful.

Speaker 2

Well, I think you touched on a couple of them right there in the question. It's certainly power and sponsorship is critical and that we believe is a reflection of our underwriting making sure that we are underwriting and lending to sponsors that certainly have the capability to solve problems should they arrive. As you've seen in most of our office loans, we've got to modify several of them, right, with sponsorship coming in with fresh cash as an effort to support the asset whether that just be for interest carry or TIs for new tenants or what have you. But when sponsorships willing to put in additional capital that says a lot. The second thing I would point to there really is that is I believe it is our underwriting and our asset management.

Speaker 2

We get accused of asking a lot of questions and being very diligent by our borrowers which I think they appreciate. But we certainly want to make sure that we drill down, we understand the asset, we understand the market and again we're really relying heavily on sponsorship and their experience. So I think that's a function of the fact that we're choosing the right sponsors and we're diligencing them appropriately.

Speaker 5

Got it. That's helpful. It's nice to see the new lending continue. You guys have been able to kind of do that at a slow steady pace. But I guess that was prior to some of the market disruptions in early April.

Speaker 5

So have you seen much of an impact on your existing pipeline there? And do you guys have any expectations on portfolio growth for the balance of this year?

Speaker 1

So we haven't really seen any change in the pipeline as a result of the volatility in April. It's really been more capital markets volatility, interest rates, bond spreads, etcetera. Borrowers still have a lot of loans that they need to refinance this year and I don't think that's going to change. Borrowers are certainly being more thoughtful about whether they're going to go floating rate or fixed rate today. It's just a little bit more challenging for them, but the pipeline still remains pretty robust I would say.

Speaker 1

So no issues there. In terms of the pipeline for the rest of the year, I mean, we're underwriting two loans right now. One's in diligence for about $28,000,000 We have another that we're negotiating heavily, just under $20,000,000 that we hope to sign up and have closed by the end of the quarter. And then through the end of the year, I think the pace of the loans rolling off the books will dictate what new originations we put on.

Speaker 5

Got it. That's helpful. If I could just squeeze in one last quick one. Do you guys have any updates you could share on the Yardley office? Should we expect the sale for that at some point in 2025?

Speaker 2

Right now the plan for Yardley really is probably to remain on the books through 2025 and then evaluate we'll evaluate that with the board towards the end of the year. It currently is producing and contributing to our DE. I mean I think it was $0.25 or almost $03 in this quarter. So we're just we're happy having it contributing to earnings as well. So there's no rush there.

Speaker 2

I think we've got a wall on that property of almost five years or six years. So the rent roll there is stable. The management team is doing a great job and there has been activity for Turing for some of the Vegas space there. So we anticipate there might be another lease sign here by the end of the year if all goes well.

Speaker 5

Got it. It's a great position to be in. Thanks for taking the questions and congrats on a good start to the year.

Speaker 2

Thank you.

Operator

And your next question comes from Jason Stewart with Janney Montgomery. Please go ahead.

Speaker 6

Thank you for taking the questions. Just a couple more on the portfolio. There's a handful of maturities, initial maturities in 2Q twenty twenty five. Is your expectation that these pay off or that they're extended? Maybe specifically if you could give us an update on Downers Grove there since I think we've already passed the initial maturity date?

Speaker 2

Yes. Sure. For Downers Grove the loan was extended through May 23. We are working on a longer term extension there with sponsorship. We anticipate that will probably be a twelve month extension and concurrent with that would be a pay down of some sort.

Speaker 2

So that property is performing quite well. They were in the market to refinance. There was a tenant there that went bankrupt so that delayed things. But they've been a great sponsor to work with. And as I said, the anticipation is that we're going to finalize a longer term extension with a material pay down maybe of upwards of $3,000,000

Speaker 6

Okay. That's helpful. And I think you have retail, there's a multi, there's a couple of other maturities in 2Q.

Speaker 2

Yes. Sure. So for Q2 we've got we have five loans that could potentially repay. We have two multifamily projects that are under application. We also have an industrial asset that is under application, a retail asset that is and two retail one retail asset under application and another retail asset that's under PSA for sale.

Speaker 2

So we anticipate total of five assets potentially up to about $145,000,000 in total commitments could prepay at the end of Q2 bleeding maybe into early Q3. It's really a function of the markets we're in today, right? While there several of those are going to be refinances, we're certainly sensitive to kind of what's happening in the market and should a lender on a refinance decides to change terms, they might come back to us for an extension rather than refi. So we're watching that closely.

Speaker 6

Got it. Okay. And then just pulling way up on the ROE of new origination activity. If you could just give us a sense like if this whole portfolio transition to tomorrow, what would you expect the gross ROEs to look like on new origination activity?

Speaker 1

Well, so for the incremental investments that we're seeing today, given the deals that we're pricing, I mean, we're seeing low teens ROE on those investments given our borrowing costs. And that's what we alluded to earlier, being really thoughtful about as loans mature and as we put new assets on the books, how to maximize that ROE obviously without sort of sacrificing credit. So, it's kind of a good position to be in, I guess. And so let's say low teens is what we're targeting right now.

Speaker 6

Okay. And just one last one as we think about the dividend and timing. Obviously, the payoffs, I get how they could move around a little bit. How are you thinking about timing of evaluating the dividend if you're thinking about this? I mean, you waiting for loans to pay off to make an adjustment to the new environment?

Speaker 6

Are you thinking about

Speaker 5

how are you thinking about that in terms of timing?

Speaker 3

Sure. It's a good question. It's something that our Board of Trustees discusses each quarter and that's in conjunction with our overall forecast and our expectations around repayments and redeployment. So it's important to reiterate that our whole loan portfolio is performing and very strong, but we are expecting certain headwinds from a market standpoint. And then with the repayments that Tom talked those are at higher net interest spreads than what we're originating.

Speaker 3

So we'll continue to evaluate it each quarter.

Speaker 6

Okay. All right. Thanks for taking the questions. Appreciate it guys.

Operator

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

Speaker 2

Thanks everyone for joining our call today. We look forward to seeing many of you at the upcoming NAREIT Conference in June. Please reach out to Investor Relations if you are interested in scheduling a meeting with Seven Hills. Operator, that concludes our call. Thank you.

Operator

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

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Earnings Conference Call
Seven Hills Realty Trust Q1 2025
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