The REIT sector is still a good place for value investors to find beaten down bargains. In this article, I’m focused on Broadmark Realty Capital (BRMK), whose share price has declined by 20% since the start of the year. I evaluate what makes Broadmark an attractive investment at the current valuation; so let’s get started.
(Source: Company website)
A Look Into Broadmark
Broadmark is a commercial mortgage REIT that is focused on construction, redevelopment, and land development loans. It was founded in 2010, and since then, it has funded over 1000 real estate loans with an aggregate face amount of approximately $2B. As seen below, Broadmark has seen a rapid growth in its active loan portfolio over the past 6 years.
(Source: Company Earnings Presentation)
What I like about Broadmark is that it is conservatively managed with zero debt and has strong liquidity, with $218M in cash on hand. Its 100% fixed rate senior secured assets also benefit during the declining interest rate environment that we are in today. In addition, management has prioritized safety of the loan portfolio, with a weighted average 59.9% LTV (loan-to-value) on assets spread across 11 states and the D.C. area.
I see this as being a positive, as it ensures that its borrowers have significant skin in the game, thereby reducing the likelihood of a default. Broadmark generates attractive yields on its portfolio, with a weighted average 12% on its fixed-rate investments, and a 4.7% yield on its fee rate investments.
While Broadmark is conservatively run, it doesn’t come without risks. For one thing, it has exposure to states that have been harder hit by COVID, such as Florida and Texas. It also has exposure to sectors that are more vulnerable to the pandemic. As seen below, the higher risk sectors of retail/offices, hotel, and senior housing makes up 14% of its loan portfolio.
(Source: Company Earnings Presentation)
However, I see Broadmark as being fairly well-protected from defaults, as it has collection measures in place to mitigate and even, in some cases, come out ahead in the case of a default. This is supported by management’s note during the last conference call:
“Indeed, in some cases, contractual defaults increased total return as a result of our earning default interest and other fees. At June 30, we had 30 loans in contractual default, representing 16% of our total portfolio value. The majority of these loans entered into contractual default status in March and April, as we proactively began to work with our borrowers and to exercise our lenders’ rights.
Note that our estimated losses on current contractual default is approximately $6.8 million, approximately, 3% of the principal outstanding on the loans in contractual default status and less than 1% of our total portfolio value. And for most loans that experienced a contractual default, we resolve the issue and collect all contractual interest and fees.”
As such, I see Broadmark as having a fairly resilient business model, with the ability to weather through the current macroeconomic difficulties.
Looking forward, I see a significant opportunity for Broadmark continue its trajectory of growth. This is supported by analysis from Freddie Mac, which showed that there is a 2.5M cumulative shortage in the number of housing units. This, combined with low interest rates, resulted in a 4.8% YoY growth in home sales during the month of August.
In addition, bank consolidation since the Great Financial Crisis has narrowed the number of lenders making construction loans, and COVID-19 disruption has further impaired the ability of leveraged banks to fund loans. I see Broadmark as being in a solid position to capitalize on the imbalance between the reduction in lender supply and the favorable demand characteristics that we are witnessing.
While REITs generally use FFO as a measure of profitability, mortgage REITs such as Broadmark generally use EPS, since they do not have the same depreciation considerations. As seen below, Broadmark is expected to have a down year in 2020 (primarily due to weakness in the first half), but is expected to rebound strongly next year, with a nearly 20% EPS growth. This puts Broadmark’s 2021 forward P/E at 10.6, which I find attractive, considering Broadmark’s prospects for growth.
(Source: Seeking Alpha)
Lastly, I find the 7% forward dividend to be attractive, especially in the current low interest rate environment. Management did reduce the monthly dividend from $0.08 to $0.06 per share to match earnings. However, the new rate is completely covered at a 100% payout ratio (based on Q2 earnings). Over time, I would like to see the payout ratio trend down to the 80% range.
2020 is expected to be a down year for Broadmark, primarily due to weakness in the first half. However, I see the company as having a resilient business model with adequate protections against borrower default. Looking forward, I expect to see the business rebound and grow, as it capitalizes imbalances between lender supply and demand for lender financing.
I also find the valuation to be attractive, especially considering the company’s growth prospects for next year and beyond. Lastly, the 7% yield is covered by earnings, and is relatively high compared to what the S&P 500 (SPY) is offering. For the aforementioned reasons, I have a favorable view of the stock and see upside potential from the current price.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.