Top pick for dividend growth: BrightSpire Capital Stock (NYSE: BRSP)
Co-produced with Beyond Saving
One thing I love about investing is that every year brings new challenges. While history does a lot of rhyming, each year has its own unique flavor. With time and experience you can develop a good idea of what might happen, but you have to be prepared to adapt.
See, I can’t sit here and pretend that I know exactly how 2022 is going to pan out. I cannot guarantee you whether in December 2022 we will return to a green or red year. I have my ideas and predictions, guided by decades of experience and extensive historical research. But there will be curve balls. The unexpected and the improbable will happen. It’s life.
Yet, there is one thing I know beyond a shadow of a doubt: whatever happens next year, there will be opportunities to increase your income. Through good times, bad times, inflation, deflation, stagflation, high interest rates, low interest rates and the complete unknown. There is always a possibility to increase your income.
In December 2019, who could have imagined the impact that COVID-19 would have on our world, our lives and our investments? Fear, uncertainty and, above all, opportunities to increase our income.
In the most difficult times, my HDO family and I persevered, identifying opportunities to increase our sources of income. Then came 2021, which had a very different flavor. 2020 was the year of COVID, where we increased our income by buying very undervalued investments, taking advantage of market fear. 2021 was the year of the dividend increase. Our earnings increased as many of the picks we bought in 2020 started increasing dividends.
As we look to 2022, we present a dividend opportunity that is positioned to outperform the market and, more importantly, to grow our earnings through rising dividends.
BrightSpire Capital (NYSE: BRSP), with a yield of 7.8%, is a reborn commercial mortgage REIT. We eagerly bought it in 2020 when blood was on the streets at unbelievably low prices. Then in 2021 we bought more as we recognized that its dividend would be increased. Yet despite BRSP’s big recovery, it’s still undervalued and underrated.
Let’s take a look at how the BRSP has changed since COVID, and its prospects for increased dividends and substantial price increases as the market recognizes its value.
More than just a name change
BRSP was formerly called “Colony Credit”and traded under the symbol “CLNC”. They changed their name as a sign of a break with their past. The name change itself is not particularly significant. What is important is that BRSP has materially restructured its entire corporate structure.
BRSP didn’t just give the same old company a new name. BRSP has changed many things, including its management, its portfolio and its strategy. When the rubber hits the road, management, portfolio and strategy are the three defining characteristics of an mREIT.
We all know people who are trying to lose weight. They diet and lose maybe 20 pounds and gain it back a few months later – constantly jumping off a fad diet with only temporary results. They haven’t really made any major changes in their lives. But have you known anyone who is truly committed to changing their lifestyle? They lose hundreds of pounds to the point that they don’t even look like the same person anymore. They train, eat healthy and maintain their weight. This kind of change is very difficult, and congratulations to those who can do it!
BRSP is this second type. The kind that made a real change and is almost the opposite of what it was. It has gone from a bloated collection of random loans with no direction, mismanagement, and motivation, to a lean, nasty, dividend-producing machine!
For mortgage REITs, management ultimately plays a huge role in success or failure. The types of mortgages the business seeks, the amount of leverage used, and how it underwrites risk are all management decisions that have significant long-term impacts on the business.
Previously, BRSP was managed externally by Colony Capital (NYSE: DBRG). In 2021, he reached an agreement to end the management contract and internalize the management. DBRG had a wide range of investments and never dedicated the time needed to properly care for BRSP. The lack of DBRG concentration resulted in the lack of BRSP concentration. There was a one-time cost associated with terminating the contract, but now BRSP has higher cash flow and dedicated management that focuses solely on BRSP.
Insourcing is an immediate benefit as it saves $0.12/share in annual general and administrative costs. While we appreciate the immediate cash, the real value is that we see a significant improvement in the quality of management.
The new CEO is Michael Mazzei. He is familiar with the mortgage markets, having negotiated commercial mortgages professionally since 1984. During his career, he has worked at Bank of America Merrill Lynch (BAC), Barclays (BCS), Lehman Brothers and was Chairman of Ladder Capital (LADR) .
New portfolio, new strategy
BRSP was already simplifying its portfolio before COVID hit. As a result, it had a good amount of cash from legacy sales when new management took over. He continued to liquidate his legacy portfolio and as of 2021, cash was over 30% of his assets.
This provided the new management team with a clean slate, keeping only the best of what Colony Credit had and redeploying cash into holdings with a new strategy.
We can see the changes BRSP has made in 2021, increasing its investment portfolio by 50%, with a much stronger focus on senior loans. Additionally, we are seeing a significant increase in loans secured by multi-family properties and a sharp decline in “others” which included items such as retail and hotel properties.
BRSP’s focus on senior mortgages makes it much more conservative. Mezzanine level mortgages have higher yields but are lower than the first mortgage, the legacy portfolio has seen the costs of seeking yield. Going forward, BRSP will only invest in mezzanine debt with existing borrowers and where BRSP also has the ability to hold the first mortgage, giving them much more control in the event of default. BRSP today has a much more conservative portfolio than CLNC pre-COVID.
Multi-family properties are a great sector to be exposed to, especially in an inflationary environment. Apartment leases tend to be short-term, typically one year. Thus, rents can be increased each year to keep up with inflation. With rising rents across the country and soaring investor demand for multifamily properties, BRSP borrowers should have little difficulty paying their mortgages.
Interest rate uncertainty
The trillion dollar question for 2022 is “will the Fed raise rates, when will it do it, and how far will it increase?”
Although I like to speculate on this important question as much as anyone else, the answer is “it doesn’t matter”. Why? Because I intend to increase my income, whether the Fed raises the target rate, keeps it the same or decides to experiment with negative rates.
The BRSP falls into the category of investments that are currently yielding a fantastic return and have the opportunity to increase the dividend sooner rather than later. If rates go up? Almost all (99.7%) of BRSP’s loans are variable rate with an average floor of 1.1%. This means that if LIBOR rises above 1.1%, BRSP’s income increases!
This makes it an excellent hedge against the risk that the Fed decides to launch a rate hike cycle. If the Fed maintains the dovish path, then BRSP will continue to increase its dividend by expanding its portfolio as it has done over the past year. Looking forward to 2022, we expect BRSP dividend growth regardless of what happens with the Fed.
BRSP reinstated its dividend in the first quarter of 2021, from $0.10/quarter, and increased it three times this year to $0.18/quarter. Distributable EPS was $0.26 in Q3, providing dividend coverage of over 140%.
In 2022, we expect dividend growth to continue by another 30-40%, which would bring the forecast return from purchases today to over 10%! Even with this level of dividend growth, BRSP would still pay a less aggressive dividend than its peers as a percentage of book value.
In addition to 30-40% dividend growth, BRSP has substantial price upside thanks to trading at a steep discount to book value. Most peers currently trade at book value or at a premium to book value. Premium commercial mortgage REITs can trade at a premium of 20-30%. It will take some time for BRSP to gain market confidence and trade at such a premium. For 2022, we expect BRSP to close the gap and even trade at a modest 5-10% premium.
BRSP is currently trading at a discount of over 20% to book value. This means there is room for capital gains of 30-40%, on top of the BRSP dividend.
It will take some time for the market to adapt to the drastic changes brought about by BRSP and to accept that these changes are permanent. As BRSP continues to increase its earnings and increase its dividend, the market will rally and rush. Since you are reading this, you will already be there waiting to take advantage of the upside.
We anticipate the BRSP earnings report in the fourth week of February.
The bottom line is that BRSP is a reborn company. It bears very little resemblance to the colony credit that existed before COVID. The market has been slow to recognize these changes and continues to value the BRSP at a substantial discount to its fair value.
We expect dividend growth of 30-40% from the BRSP, plus 30-40% from the potential for capital gains. He touched the trinity that is so hard to find:
- A high yield right now.
- Significant dividend growth.
- Sharp rise in prices likely to materialize within a year.
Whatever new challenges 2022 brings, BRSP is a choice I want on my team – to increase my income and ensure I have the cash to take advantage of market opportunities.