Impact of Interest Rate Changes on High-Yield REITs

Direct Financial Impact and Borrowing Costs

High-yield REITs are mitigating rising borrowing costs through strategic measures like reducing repurchase agreements and using hedging instruments. Changes in borrowing rates and yields directly impact net income, while inflation increases financing costs and refinancing difficulties. Interest expenses significantly burden earnings, with borrowing rates often tied to SOFR.

"As borrowing costs remain high, we have taken steps to limit the impact of rising rates through reductions in our repurchase agreements, exercising swaptions to pay-fixed rate swaps, and adding swaptions as a hedge for future liabilities." --- (CIM, sec filing, 2024/Q1)

"Changes, both increases and decreases, in the rates the Company is able to charge its borrowers, the yields the Company is able to achieve in its securities investments, and the Company’s cost of borrowing directly impacts its net income." --- (LADR, sec filing, 2024/Q1)

"Additionally, inflationary periods may cause us to experience increased costs of financing, make it difficult to refinance debt at attractive rates or at all, and may adversely affect the properties we can acquire if the cost of financing an acquisition is in excess of our anticipated earnings from such property, thereby limiting the properties that can be acquired." --- (O, sec filing, 2024/Q1)

"But the interest expense associated with these loans continues to burden our results, impacting 1Q earnings by $0.16 per share." --- (BXMT, earning call, 2024/Q1)

"Economic Interest Expense and the Cost of Funds The borrowing rate at which we are able to finance our assets using secured financing agreements is typically correlated to SOFR and the term of the financing." --- (CIM, sec filing, 2024/Q1)

Impact on Dividend Yields

High-yield REITs face uncertainty in maintaining current dividend levels due to interest rate changes, as highlighted by Realty Income. Ladder Capital suggests bonds may become more attractive if yields align. Chimera Investment Corporation considers multiple factors, including dividend yield, in determining payouts. Blackstone Mortgage Trust notes the high return on capital required to sustain dividends.

"Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period." --- (O, sec filing, 2024/Q1)

"And I think I've said a few times on these calls that, if the dividend and the yield on bonds is the same, you should probably buy the bond because you're going to have to buy that one day anyway." --- (LADR, earning call, 2024/Q1)

"Other metrics that our Board of Directors may consider when determining the amount, if any, of dividends on our common stock include (among others) REIT taxable income, dividend yield, book value, cash generated from the portfolio, reinvestment opportunities and other cash needs." --- (CIM, sec filing, 2024/Q1)

"You talk about sort of the sustainable dividend and the economics. Given where book value is today, to earn that dividend would require about a 10.5% return on capital or economic return, which is a pretty high watermark for you guys." --- (BXMT, earning call, 2024/Q1)

"Our approximately 4% AFFO per share projected growth rate, paired with our estimated annualized dividend yield of approximately 6% is why we believe our platform offers one of the most compelling investment opportunities in the S&P 500. With that, I would like to open it up for questions." --- (O, earning call, 2024/Q1)

Effect on Property Valuations

Interest rate changes impact property valuations in high-yield REITs through adjustments in impairment measurements, validation of valuation processes, and significant management estimates. Methods like direct capitalization rate and sales comparison are used to estimate fair values, with higher rates causing temporary impacts on specific asset classes.

"To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the property over the fair value of the asset and reflected as an adjustment to the basis of the asset." --- (LADR, sec filing, 2024/Q1)

"As I mentioned in our remarks, the losses between the first and second quarter are coming in right on top of our year-end CECL reserves, which we think is a great validation of our valuation process." --- (BXMT, earning call, 2024/Q1)

"Management has made significant estimates in several areas, including current expected credit losses of Non-Agency RMBS, valuation of Loans held for investments, Agency and Non-Agency MBS, forward interest rates for interest rate swaps, and income recognition on Loans held for investments and Non-Agency RMBS." --- (CIM, sec filing, 2024/Q1)

"The Company generally will use the direct capitalization rate valuation methodology or the sales comparison approach to estimate the fair value of the collateral for loans and in certain cases will obtain external appraisals." --- (LADR, sec filing, 2024/Q1)

"And then on the multifamily side, as I mentioned, really looking at temporary impacts of supply in certain markets compounded by higher rates, but there -- those are watchlist assets, just 1% of the overall portfolio and where we expect it to be pretty marginal." --- (BXMT, earning call, 2024/Q1)

Sector-Specific Impacts

High expenses and insurance issues are causing damage in the mezzanine and multifamily sectors despite rising rents. Diversification helps some REITs mitigate disruptive interest rate impacts, while the U.S. housing market shows resilience. However, economic conditions remain uncertain, affecting portfolio stability.

"And those that are going to lose them are going to lose them. And I think you're seeing some pretty widespread damage in the mezzanine sector and in the multifamily sector where people bought very tight cap rates and now they have high expenses even though rents have doubled." --- (LADR, earning call, 2024/Q1)

"Consequently, we would highlight the diversification of our portfolio, which today consists of over 1,500 clients in all 50 states, the UK and six other countries in Western Europe, all of which helps insulate us from potential disruptive interest rate and credit events that could impact the durability of our cash flow." --- (O, earning call, 2024/Q1)

"This process requires significant judgments about future events that, while based on the information available to us as of the balance sheet date, are ultimately indeterminate and the actual economic condition impacting our portfolio could vary significantly from the estimates we made as of March 31, 2024." --- (BXMT, sec filing, 2024/Q1)

"We expect to take a long-term view of assets and liabilities. Business Update The U.S. housing market has continued to show resiliency despite the impact of higher mortgage rates." --- (CIM, sec filing, 2024/Q1)

"And so I suspect that rents continue to rise and that'll be helpful. But the insurance side of the multifamily sector is particularly problematic, so I suspect it'll continue." --- (LADR, earning call, 2024/Q1)

Strategic Responses to Interest Rate Changes

High-yield REITs are strategically responding to interest rate changes by increasing yields on interest-earning assets, employing hedging strategies, utilizing swaps to protect against floating rate liabilities, and anticipating a resurgence in sale-leaseback transactions as rate stability improves.

"However, during the quarter ended March 31, 2024, the yields on our average interest earning assets increased by 30 basis points to 5.8%, as compared to 5.5% for the quarter ended March 31, 2023, which largely offset the effects of lower interest earning asset balances." --- (CIM, sec filing, 2024/Q1)

"Hedging Strategies We may enter into interest rate and credit spread derivative contracts to mitigate our exposure to changes in interest rates and credit spreads." --- (LADR, sec filing, 2024/Q1)

"So, I do see that changing as there is stability in the rate environment, as people start to get much more comfortable about where things are going to sort of play out, I do believe that sale-leaseback will come roaring back." --- (O, earning call, 2024/Q1)

"With the continued expectation of interest rates remaining high over the next year and lowered expectations of rate cuts for the remainder of 2024, the swaps will provide significant protection to our current floating rate liability exposure." --- (CIM, sec filing, 2024/Q1)

"This decreases was offset by an increases in interest expense on our securitized debt of $13 million as the average borrowing rates on our securitizations increased by 60 basis points and average securitized debt balances increased by $157 million for the quarter ended March 31, 2024, as compared to the quarter ended March 31, 2023. Economic Net Interest Income" --- (CIM, sec filing, 2024/Q1)

Investor Sentiment and Market Reactions

Ladder Capital Corp (LADR) is strategically managing its financing operations and cash reserves to navigate interest rate changes. By issuing new bonds when capital costs are favorable and holding cash for sustainable investments, LADR aims to maintain investor confidence and adapt to market reactions effectively.

"U.S. Treasury curve. We remain committed to financing our operations to the corporate unsecured bond market and stand prepared to issue new unsecured bonds when we believe the cost of capital is favorable." --- (LADR, earning call, 2024/Q1)

"It's pretty easy to do, especially with all the cash. But what I'd like to do that we're not holding onto our cash so that we can cover our dividend, we're holding onto our cash so that we can buy investments that last for an extended period of time and are sustainable." --- (LADR, earning call, 2024/Q1)