It’s easy to get caught up on market movements on a week by week or even day by day basis. That’s because the market is constantly trying to digest a parade of economic news and make a forecast about how that would impact a stock.
It’s important to keep in mind, however, that it is earnings that drive a stock’s long-term performance and no one can accurately predict with consistency what a company’s next earnings will be.
That’s why it’s probably better in most cases to keep a level-headed approach, especially when the market seems to be going bananas. Such may be the case with Ares Commercial Real Estate (NYSE:ACRE), which as shown below, is again trading at levels not seen since October. This article highlights why ACRE may be a good choice for high yield at present.
Ares Commercial Real Estate is a large commercial mortgage REIT that’s externally managed by big brother Ares Management (ARES), a well-known asset manager that also happens to manage Ares Capital (ARCC), the largest BDC by asset size.
ACRE benefits from its affiliation Ares Management, as the latter has $51 billion in real estate assets under management. This affiliation is valuable for ACRE, as it benefits from an experienced management team that’s in the know about real estate deal flows.
To get a sense for how cheap ACRE has gotten, let’s take a look at the following chart. At the current price of $10.29, it’s now trading well below its 200 and 50 day moving averages of $12.22 and $11.26, respectively. I see solid support, however, at the $10 level as it’s tested this level twice over the past 12 months before bouncing back up.
Meanwhile, ACRE maintains a strong portfolio of loans that comprised of 98% senior loans and notably, it’s overearning its $0.33 quarterly dividend, with $0.39 in distributable earnings per share during the third quarter. Management has also demonstrated a penchant for declaring special dividends of 2 cents per quarter over the past eight quarters. While it isn’t much, it is a meaningful 6% boost to the regular dividend rate.
I see potential for continued special dividends, considering that ACRE is out-earning the dividend by a wide margin, and due to the fact that 98% of its loan portfolio is based on floating rate. This compares favorably to 68% of ACRE’s own debt being floating rate, enabling it to take advantage of an increasing investment spread (between income generating assets and cost of capital). As shown below, management expects to see meaningful annual distributable EPS growth of around $0.06 without hedging for every 50 basis point rise in interest rates.
Risks to ACRE include its modestly high loan exposure to office properties, which comprise 34% of its loan portfolio. This is followed by generally perceived safer asset classes of multifamily (20% of loan portfolio), mixed use (11%) and industrial (10%). However, management is addressing this potential risk by pivoting the loan portfolio towards non-office related property classes.
This is reflected by the $50 million of floating rate investments made across multifamily and self-storage properties and $28 million of AAA-rated newly issued CRE liquid debt securities made during the third quarter alone. Having said that, challenges are likely to persist into this new year, but that’s where ACRE’s relationship with Ares Management comes in handy, as noted during the last conference call:
The Federal Reserve is continuing to tighten monetary policy with an unexpected pace of increases in market rates to combat inflation, which we believe has increased the likelihood of a recession. These complex macro cross currents are driving volatility across most major asset classes, including commercial real estate.
Because of all this, the sourcing, informational benefits and deep financing relationships that we derive as part of the Ares platform will be even more important for us in this type of environment. We have been focused on property types such as multifamily, industrial and self-storage that have strong underlying rent growth dynamics, which has muted or outpaced the recent growth in market interest rates. This has been particularly true since we exited the COVID time period at the end of 2020.
Meanwhile, ACRE is well-positioned from a balance sheet perspective, as it’s modestly levered with a 2.3x debt to equity ratio and a recourse debt to equity ratio of 1.3x, and has strong available capital of $156 million. It also appears that the market has baked in a substantial amount of risk into the share price.
At the current price of $10.29, ACRE trades at a price to book ratio of just 0.73x, giving investors a 27% discount to book value. As shown below, this sits well below ACRE’s average valuation over the past 5 years outside of the early 2020 timeframe. Analysts have a consensus Buy rating on ACRE with an average price target of $13.21, translating to potentially very strong total returns.
ACRE benefits from its relationship with large asset manager Ares Management, providing it valuable market insights and deal flow. It has a portfolio of mostly senior loans and is set to continue to benefit from rising rates. While its office exposure is a risk, management is making moves to pivot away from this sector.
Meanwhile, it pays a well-covered dividend. The drop in ACRE’s price has pushed its dividend yield including special dividends to 13.6% and 12.8% based on the regular dividend alone. While no commercial mortgage REIT is a sleep well at night stock, the high yield and attractive price to book ratio makes it a compelling income stock for a well diversified portfolio.