Social Capital in Ladder: A Phoenix Rises (NYSE: LADR)
Recently, I wrote an article titled “The most important thing for REIT investors.“And yes, for those of you who follow me regularly, I still brag about it.
It’s too important not to.
For those of you who haven’t read it – or the follow-up article I wrote the next day – I’ve pointed out the margin of safety. It is the concept of buying at sustainable prices rather than too high prices.
It’s much easier to make money this way. It’s also much easier not to lose what you’ve already done.
As I explained:
“When financial markets fail to fully price fundamental values into security prices, an investor’s margin of safety is high.”
In my opinion – and based on my 30+ years of investment experience – the concept of margin of safety is one of the most important ways to generate wealth. Even in the 10 years I’ve written about Seeking Alpha, I’ve watched my personal wealth mushroom because of this very simple concept.
In this regard, March 2020 did not hurt, as most stocks were put on sale, waiting to be bought. To be clear, this was no ordinary sale; it was a once in a lifetime eruption!
And boy, did I act on it – after doing my due diligence, of course.
I advised you all to act accordingly too, if you remember.
As value investing founder Benjamin Graham explained,
“A market downturn is the true test of an investment philosophy.”
In which case, safety margin passed hands down.
Introducing Ladder Capital, Then and Now
Going back to the issue of due diligence for a moment, here is some of what I wrote at the end of last March. In “Cash Is King”, I explained how REITs are:
“… still suffer from most market-wide sell-offs… But that doesn’t mean they won’t fully recover, as long as they have enough cash on hand. The more, the better. Because, again, we don’t know how long this will last.
I also highlighted Ladder Capital (LADR), a commercial mortgage REIT that “felt nearly 57%” at the time. In short, its price was that of bankruptcy, despite:
- $6.5 billion in assets, including $350 million in cash; $1.7 billion in CMBS loans; and $3.2 billion in bridge loans, 96% of which are senior secured and most are floors
- $1.2 billion in real estate, including $792 million in net leasehold properties with an average lease term of 13 years
- $130 million in mezzanine loans
Stocks were returning a whopping 21% when I wrote this article – “on what I would describe as one of the most irrational trades in the REIT industry right now.”
So I recommended to my iREIT community on Alpha to take advantage of the situation and save the truck.
It was also when I first introduced my Covid-19 wallet called Cash is King. In this document, we have purchased shares of REITs such as:
- Hannon Armstrong (HASI), now up 171%
- Essential Properties Realty (EPRT), up 136%
- Ladder Capital, now up 107%
- Sales (VTR), now up 99%.
And, as you can see from the chart above, Ladder hasn’t even recovered from its pre-pandemic levels yet.
That’s why many readers asked for an update. So this is it…
The mREIT ladder business model
The last time I wrote about Ladder was at the beginning of June. Not so long ago, but here’s a reminder all the same.
Ladder Capital – alongside Arbor Realty Trust (ABR), Broadmark Realty (BRMK) and Granite Point Mortgage Trust (GPMT) – is one of the few internally managed mortgage REITs. It also has notably high insider participation, at over 10%.
Both of these attributes are positive and not so common. Yet somehow, it’s one of the few commercial mortgage REITs (mREITs) still trading well below 2019 levels.
How did it happen exactly?
Well, the company came under tremendous pressure in 2020 as liquidity and collateral issues exploded almost overnight. This is at least somewhat understandable since Ladder’s core competency is commercial real estate lending (“CRE”).
But it also maintains a securities and equities business. So let’s analyze its $5.4 billion asset pool and estimate the fair value of the $1.5 billion in equity…
Ladder’s current portfolio has a modest allocation primarily comprised of short-term, AAA-rated, CRE-guaranteed loans. Its weighted average duration of 1.9 years and other features mean there is little to no interest rate sensitivity, which provides a reserve of liquidity as needed.
Its second largest allocation, however, is to physical real estate. Ladder’s $1.2 billion undepreciated value portfolio is 65% net rental properties with an average remaining lease term of 11 years.
These are an excellent anchor for all Ladder activities due to their stability and natural protection against inflation and interest rates.
Learn more about how Ladder Capital works
Now, traditional CRE loans represent 71% of Ladder’s assets and business. The REIT focuses on first mortgages, which are the highest and therefore the safest in the capital stack.
These have a weighted average loan-to-value ratio of 69%. This LTV is in line with most of its peers. But we cannot assess what they truly represent without a better understanding of the types and quality of real estate behind them.
(Source: Ladder first quarter results presentation)
For starters, 94% of commercial real estate loans are secured first lien. Barring a massive drop in property values - and we’re talking over 30% – and a forced liquidation at the worst possible time…
Ladder is very unlikely to absorb a loss of principal in this particular trading division.
The 1.3 year weighted average duration of the loan portfolio is exceptionally low and provides great sustainability when interest rates rise. Moreover, the loans themselves are almost exclusively variable rate.
Again, this makes it more unique compared to peers like Blackstone Mortgage Trust (BXMT) and Starwood Property Trust (STWD). This superior positioning is due to Ladder’s distinctive approach to bridging light loans.
(Source: Ladder first quarter results presentation)
Diversification is part of any good risk management plan. Even the most sophisticated and smart CRE lender in the world would not be in an enviable position if it decided to consolidate its loan portfolio strictly in tourist areas like Minneapolis and Portland.
So I’m happy to say that Ladder is well diversified by property type and geography. At the same time, there are two elements that we must carefully assess…
And that would be its 11% retail and 14% hospitality exposures.
Fortunately, the loan portfolio has recorded an impressive recovery rate of 99% over the past 12 months. This stat alone paints a powerful picture of his performance.
It is equally important to note that Ladder is rated BB+. This is one point below investment grade, which puts it among the highest in the mREIT universe.
So…again…why on earth is the Ladder stock price in trouble?
(Source: Scale First Quarter Earnings Supplement)
Resisting the shock of 2020 has been expensive. Necessary changes to the portfolio, including building up a large cash stack, caused the return on equity to plummet.
A smaller, less risky portfolio with lower leverage and lower return on equity adds up to one thing: less cash flow.
Amid all of this, I’m happy to say that CEO Brian Harris has been transparent about Ladder’s challenges since the shutdowns began. That’s why we have very good reasons to trust it – one more brand worth investing in.
As such, I’m also happy to say that Ladder finally saw new net loan growth in April.
For all these reasons and more, we are cautiously optimistic that its net creations will accelerate in May and June. It is July 29, but after I published this article.
So you better believe I’ll check this out when it’s released.
For reference, Ladder’s generally accepted accounting principles (GAAP) book value per share ended in Q1-20 at $12.31. And – to the surprise of those who saw the stock plunge more than 70% at the start of 2020 – that figure increased in the second and third quarters.
By the end of Q1-21, it had admittedly fallen to $12.08. But that gives us a 9% discount on today’s closing book value of $11.00.
We consider $10.75 an attractive entry point as this mREIT recovers.