Mortgage REITs (mREITs) have more in common with a bank than with a typical REIT. That's because, instead of collecting rental income, they make money originating and holding loans. This business model enables mREITs to make a lot of money during good times. Further, because they're REITs, they must distribute the bulk of that income to their investors, which is why they tend to have high-yielding dividends.
Unfortunately, those dividends usually fluctuate with market conditions, which is why mREITs aren't ideal for those seeking a steady income stream. However, for investors willing to take on more risk in exchange for a higher reward income opportunity, mREITs can be an intriguing option. Two that stand out as the most compelling buys this month are Arbor Realty Trust (NYSE: ABR) and Ladder Capital (NYSE: LADR).
Stability in a sector not known for it
Arbor Realty Trust is an mREIT focused on financing commercial real estate, primarily related to multifamily housing. The company not only originates loans that it holds on its balance sheet and sells to government-sponsored entities (GSEs) and agency buyers but also services those loans.
This business model generates fee income from loan originations and recurring income streams from servicing fees and interest income on the loans held on its balance sheet. About 83% of its balance-sheet loan portfolio is for multifamily properties, with the other 17% spread across office, healthcare, land, student housing, hotel, self-storage, and other properties.
Arbor's diversified operating platform and multifamily focus have generated solid earnings across the real estate cycle. Because of that, it has a stellar dividend track record for an mREIT. For instance, the company has increased its dividend for nine consecutive years, including its last four quarters. The payout has grown 13.3% over the past year, pushing the yield up to 7.6%. That's more than double the yield of the average REIT.
The company has steadily increased its dividend by focusing on originating and holding loans in the attractive, stable multifamily sector while maintaining a conservative financing strategy. Those factors could enable Arbor to continue growing its dividend in the future.
Repositioned and ready to grow
Ladder Capital is a unique mREIT. While it primarily originates and owns loans backed by commercial real estate, it has equity investments in a diversified commercial real estate portfolio, making it more of a hybrid REIT. Those real estate holdings generate stable income for the company.
The company's loan business experienced some turbulence in 2020 as the pandemic impacted loan values. That forced Ladder Capital to take several steps to shore up its liquidity so that it could meet the margin calls on its debt, including selling loans and properties, cutting its dividend by 41%, and securing capital from outside investors. The company also stopped originating new loans while shrinking its asset base.
Those moves helped put the company's financials back on solid ground. The mREIT ended 2021's first quarter with more than $1.3 billion in cash, giving it lots of financial flexibility. That's enabling it to go back on offense by starting to originate new commercial mortgage loans backed by various property types. Meanwhile, it has the flexibility to grow its equity portfolio by purchasing additional cash-flowing commercial properties.
Despite last year's massive dividend cut, Ladder Capital yields an attractive 6.8%. That payout has upside potential as the REIT puts its cash to work, originating new loans and expanding its real estate portfolio. The combination of income and upside makes Ladder Capital stand out in the sector as it could produce significant total returns if it makes wise investments with its cash balance.
Big-time yields with compelling upside potential
Arbor Realty and Ladder Capital stand out in the mREIT space. In addition to offering high-yielding dividends, they have compelling growth potential. Arbor has an excellent track record of growing its multifamily-focused loan and servicing portfolio, which has enabled it to increase its dividend steadily.
Meanwhile, Ladder Capital has repositioned itself as a cash-rich company with lots of flexibility to expand its loan portfolio and property holdings, which could drive dividend growth in the coming years. The combination of yield and growth could enable these mREITs to produce attractive total returns, making them stand out as compelling buys this July.