Q4 the Most Productive Period for Seven Hills
Real estate investment trusts (REITs) got a big boost in early November 2023 after the Federal Reserve hinted that rate cuts were coming. Specialty mortgage REITs (mREITS) like Seven Hills Realty Trust (NASDAQ:SEVN) received an even bigger boost in mid-December 2023 after the Fed signaled that multiple rate cuts were on the table in 2024. (Source: “December Fed Meeting: Officials Anticipate 3 Rate Cuts In 2024,” Forbes, December 13, 2023.)
It took a while but the Fed announced its first rate cut, with a bigger-than-expected half-point reduction, in September 2024, followed by a 0.25 basis cut in November and December. This brought its key lending rate down a full percentage point to a target range of 4.25% to 4.5%.
The federal funds rate is the rate at which banks borrow and lend to each other overnight. It’s not the rate consumers pay, but it still affects the borrowing and savings rate.
For REITs and mREITs, though, the federal funds rate is important. Higher interest rates make it more expensive for REITs and mREITs to borrow and pay down debt. Higher interest rates can cut into profit margins, too.
Are lower interest rates affecting U.S. mortgages?
Won’t lower interest rates mean less interest income for mREITs?
Fifteen-year and 30-year mortgage rates are fixed and essentially tied to Treasury yields, and they are not falling in step with Fed policy. Since most Americans have fixed-rate mortgages, their rates won’t change unless they refinance or sell their current home and buy another property.
According to the most recent data, the average rate for a 30-year, fixed-rate mortgage is 6.67%. This is far higher than the 2024 low of 6.08% in September. (Source: “Mortgage Applications Increase in Latest MBA Weekly Survey,” Mortgage Bankers Association, December 11, 2024.)
Moreover, even when lower mortgage rates do trickle down, it should lead to more lending, which is also good for an mREIT like Seven Hills Realty Trust.
About Seven Hills Realty Trust
Seven Hills Realty Trust focuses on originating and investing in first mortgage loans secured by middle-market and transitional commercial real estate (CRE) in the U.S. (Source: “Investor Presentation September 2024,” Seven Hills Realty Trust, last accessed December 12, 2024.)
Management describes middle-market CRE as commercial properties with values up to $100.0 million and transitional CRE as commercial properties subject to redevelopment or repositioning activities that are expected to increase the value of the properties.
The mREIT has 22 floating-rate, first-mortgage loans diversified across various types of geography, sponsors, and property types. Total loan commitments are $652.0 million, with a weighted average all-in yield of 9.6%.
By property type, multifamily accounts for the majority of Seven Hills’ portfolio at 37%, followed by office (27%), industrial (22%), retail (9%), and hotel (5%).
There has been a swing in terms of the property mix; during the second quarter, Seven Hills’ office exposure fell to 27% from a recent high of 40% in the first quarter of 2023. This is a wise move in light of Black Swan events like the 2020 health crisis.
As an added bonus, Seven Hills has no office loans in urban or central business districts in its portfolio. Moreover, as of September 30, 2024, all of its borrowers had paid their debt service obligations owned by and due to Seven Hills.
“Delivered Solid Third Quarter Results”
For the third quarter ended September 30, 2024, Seven Hills Realty reported net income of $3.5 million, or $0.23 per share, down from $7.4 million, or $0.51 per share, in the same prior-year period. (Source: “Seven Hills Realty Trust Third Quarter 2024 Financial Results,” Seven Hills Realty Trust, October 31, 2024.)
Distributable earnings came in at $5.3 million, or $0.36 per share, down slightly from $5.6 million, or $0.38 per share, in the same period last year.
During the quarter, the mREIT closed on one new loan secured by a hotel in Lake Mary, Florida, with a total commitment of $16.0 million. It also received $70.6 million in repayments proceeds.
Seven Hills ended the quarter with cash on hand of $82.2 million and unused capacity of $317.7 million.
Commenting on the results, Tom Lorenzini, president and chief investment officer, said, “We delivered solid third quarter results with distributable earnings of $0.36 per share. Our results continue to reflect our diverse, high-quality portfolio, further demonstrated by the $70.6 million in repayment proceeds we received in the quarter.”
“With ample available capacity and a conservative leverage profile, we are well positioned to further capitalize on our robust and growing pipeline as we head into the fourth quarter, which is traditionally our most productive period of the year.”
Maintains Quarterly Dividend of $0.35/Share
As an mREIT, Seven Hills has to legally distribute at least 90% of its taxable income to shareholders. In the third quarter, it generated distributable earnings of $0.36 per share, more than enough to fully cover its quarterly dividend of $0.35 per share.
The mREIT’s third-quarter dividend of $0.35 per share translates into an annual distribution of $1.40 per share, for a forward yield of 10.27%.
SEVN Stock Has Great Long-Term Capital Appreciation
Lots of investors get bogged down by near-term share price volatility. And a reliable, high-yield dividend can help shareholders ride out that near-term instability. Now, even though SEVN stock took a bit of a hit after the mREIT reported its third-quarter financial results in late October, it has been on the rebound since then, trading up 15.5% year to date and 21% on an annual basis.
Longer term, SEVN has also performed quite well over the last two years, with total returns of 82.3%. Over the same period, the S&P 500 has rallied 50.2%.
That’s the total return with dividends reinvested. Had an investor elected to pocket the quarterly payout, the two-year total return would slip to 44.6%, less than the S&P 500’s 50.2% gain.
The near-term outlook remains bullish for Seven Hills, with Wall Street analysts providing a 12-month share price target of $14.50 to $15.00 per share. At current prices, this points to potential upside of 7.8% to 11.6%.
Chart courtesy of StockCharts.com
The Lowdown on Seven Hills Realty Trust
Seven Hills Realty Trust is a great mREIT that saw its share price take a hit during the Federal Reserve’s aggressive interest rate hike cycle in 2022 and 2023. But, with the interest rate hike cycle likely over and cuts underway, the macroeconomic and microeconomic outlooks for SEVN and other mREITs remain solid.
The mREIT continues to actively invest its capital. It closed on one new loan during the third quarter and received $70.6 million in repayment proceeds.
The outlook for Seven Hills Realty Trust is robust. Demand for CRE debt capital in the underserved middle markets is expected to remain strong as alternative lenders like Seven Hills increase their foothold.
This is a result of growing demand for alternative sources of CRE debt capital due to a slowdown in the securitized lending market and decreased lending in the banking sector.
This growth potential is why 86 institutional investors have stepped up, acquiring a 43.54% stake in SEVN. The biggest institutional holder is BlackRock Inc, with 1.02 million shares, representing a stake of 6.88%. Vanguard Group Inc is second with a 5.13% stake, followed by Morgan Stanley with 5.07%.