Commercial property lender Claros Mortgage Trust's move this week to suspend its quarterly dividend marks the latest sign of the struggle facing some mortgage real estate investment trusts trying to position themselves ahead of expected lower interest rates and restored demand for financing.
Even as the Federal Reserve has begun lowering borrowing costs, commercial property economics are under pressure. Loan portfolios remain stressed by late or no payments on the debt, particularly for lenders with significant amounts of office holdings, analysts have said. There's also some strain for owners of multifamily property because of increased supply and slowing rent growth.
As a result, lenders with ties to big investment firms such as Blackstone and KKR have been forced to set aside cash reserves and lower dividends. To make up for its dwindling capital, Claros this week said it's taking a step further by withholding dividend payments to investors on its common stock. It's also contemplating whether to foreclose on its riskiest loans.
The payment suspension for Claros, a mortgage REIT affiliate of Mack Real Estate Credit Strategies, is set to start with the fourth-quarter payout that would have otherwise come next month. After announcing the move on Tuesday, the REIT’s shares lost almost a quarter of their value, falling from $6.20 to close the day at $4.76. On Wednesday, the stock sank lower, closing at $4.32.
Mortgage REITs have been building loan loss reserves throughout the year related to underperforming loans, according to an S&P Global Ratings report in September. REITs have also downgraded their own internal risk ratings on a number of loans to higher-risk categories, the bond-rating firm said.
Dividends shrink
Beginning in the third quarter, Blackstone Mortgage Trust lowered its quarterly dividend per share about 24% to 47 cents from 62 cents. KKR Real Estate Finance Trust reduced its quarterly dividend about 42% to 25 cents from 43 cents per share. Mortgage lender Ready Capital cut its dividend 20% in September below its previous dividend payout. And Apollo Commercial Real Estate Finance announced a 29% cut that month.
“While this improves liquidity and earnings retention, we expect it to be somewhat offset by climbing liquidity needs as asset credit quality remains pressured,” S&P said in its report. “Over the next year, [commercial real estate] finance companies will, in our view, remain selective with originations and focus on preserving liquidity.”
Claros’ decision to suspend its dividend follows its move in September to reduce it from 25 cents a share to 10 cents a share.
“The board of directors suspended the quarterly dividend to preserve capital and create added financial flexibility for capital allocation decisions with the objective of enhancing stockholder value over the long term,” Richard Mack, CEO and chairman of Claros, said in a statement. “Looking ahead, the board of directors will determine whether to reinstate the quarterly dividend based on broader market conditions, the company’s financial performance and estimated REIT taxable income.”
The REIT reported losing $120.6 million through the first nine months of this year. The need to preserve capital was a focus of analysts on Claros’ third-quarter earnings call.
Risky loan volume grows
The level of risk assigned to loans in Claros’ portfolio has risen over the past couple of years of high interest rates. The REIT assigns a quarterly, one-to-five risk rating on its loans, with one being the least risky.
Of Claros’ $6.4 billion in loans held for investment, $2.44 billion was assigned its highest-risk ratings of four and five — or about 38% as of the end of September, according to its quarterly report. The REIT had another $426.8 million of elevated risk-rated loans classified as held for sale.
Since September, Claros sold two held-for-sale loans for $142 million generating excess cash of $51 million, the REIT said.
However, Claros has in the past foreclosed on such loans rather than trying to sell them. Whether it does so again is a decision that would tie up rather than generate capital, company executives acknowledged on their third-quarter call.
Claros declined to provide additional information to CoStar News.
During the third quarter, Claros moved two multifamily loans to a risk rating of four, representing a total unpaid principal balance of $325 million. These loans are with the same borrower and are collateralized by properties in Denver and Phoenix, the company said.
“The sponsor has experienced difficulties accessing the capital markets,” John McGillis, president and chief financial officer, said on the earnings call. “And while we have a positive long-term outlook on housing in these markets, we believe it was prudent to proactively downgrade these loans.”
In addition, McGillis said the company moved three multifamily loans to the highest risk rating of five. These three loans also have the same borrower and a combined unpaid principal balance of $186 million and are collateralized by assets in Las Vegas, Phoenix, and Dallas.
“These three loans were placed on nonaccrual status in the first quarter and the decision to further downgrade was made in anticipation of taking ownership of the assets over the next quarter or two,” McGillis said.
Loan loss reserve
Claros set aside $30 million as a reserve against potential losses on the loans, McGill said.
Asked on the call about how the REIT determines between whether to sell a loan or foreclose, McGillis said it’s a capital allocation decision.
“Where do we get the best return on our invested capital,” McGillis said, “and obviously, with multifamily assets, we feel like we are extremely well positioned to take advantage of that opportunity with minimal capital requirements going into these assets in the near term.
In 2023, Claros, as a mezzanine lender, foreclosed on a 1,087-key portfolio of seven limited-service hotels in New York City. The portfolio is also subject to a $300 million loan. Claros has been working with loan servicers to modify and extend the maturity of the loan while simultaneously trying to sell the portfolio.
With capital tied up in properties and reserves, Claros has seen its liquidity shrink, according to Jade Rahmani, a securities analyst with Keefe, Bruyette & Woods who emailed his latest take on Claros to CoStar News.
Claros’ cash reserves totaled $154 million as of Nov. 5, equivalent to 2.1% of assets, according to Rahmani, who said the average of its peers is 8.5%. He expects the stock to underperform.