Mortgage real estate investment trusts (REITs) are generally high-yielding investment options, but they are complicated and come with a lot of risk. That's particularly true if you don't fully understand what you are buying. But Broadmark Realty Capital (NYSE: BRMK), with a generous 7% dividend yield, changes the math for investors. In fact, this unique mortgage REIT might be the best option for conservative types looking at this niche REIT sector.
IOUs to buy IOUs
Most mortgage real estate investment trusts own large portfolios of mortgages, usually bought in the form of collateralized mortgage obligations (CMOs). Effectively, these are mortgages that are bundled up into bonds. Mortgage REITs generally use leverage, with the CMOs they own as collateral, to enhance returns. They make the spread between their interest costs and the yield on the portfolio of mortgages they own.
The leverage here, however, is a very big negative when market dislocations occur. This is because the value of CMOs can fall and lead to lenders asking for additional capital (which is akin to a margin call for individual investors). If a mortgage REIT can't come up with the capital, it will need to sell assets, usually into an already difficult market. This is the scenario that risked unfolding earlier in 2020 when the global pandemic roiled markets and did take place during the 2007 to 2009 housing-led recession -- partially because the use of leverage dividend cuts is always a notable concern for mortgage REITs.
Here's the thing, Broadmark Realty Capital doesn't use leverage. That doesn't mean that its business is immune to economic downturns. It cut its monthly dividend from $0.08 per share to $0.06 in April (more on this below). However, the REIT doesn't need to worry about a banker knocking on the door to demand money that it may not have, like most other mortgage REITs. While this is an incredibly important difference, it's not the only one you need to know about.
Dancing to a different beat
Perhaps the most important difference between this REIT and a traditional mortgage REIT is that Broadmark is a hard-money lender. This means that it provides loans directly to builders to help them fund their construction plans. The loans are generally short term in nature, with Broadmark getting repaid when the property is sold or the project gets completed.
The REIT is fairly conservative, so it generally only lends about 60% or so of the value of what it believes a project will be worth at completion. Thus, if things don't pan out as planned, the ending sales price of the project can fall materially before Broadmark takes a hit. And, in a worst case scenario where a borrower walks away from a loan, Broadmark's direct relationship with its customer means it can take over a project and finish it, salvaging its investment. That said, the April dividend cut was driven by construction delays from COVID-19, not a deluge of investments that went horribly wrong. Broadmark expects to get paid back on the vast majority of its projects, just over a longer time period on some of the ones that were delayed.
Notably, hard money lending is a unique niche where one-on-one relationships matter. Builders want to know that they can contact a lender and get a deal done quickly with a reliable partner. Broadmark is ready and able to do that (in as little as two days, sometimes less for repeat customers), at a specific cost. Loans generally earn yields of around 10% to 12%, which is a very generous range. The company also earns origination fees. However, the key is that borrowers know exactly what to expect from Broadmark and that the REIT isn't going to try to raise rates to take advantage of market dislocations to gouge its customers. Nor is it going to simply drop this line of business, like banks have, because there's other things going on that seem better. Having a consistent partner that can work quickly is worth the cost for many builders.
What's interesting in all of this is that Broadmark's business has historically been pretty boring and consistent. Although it has only been public for a few quarters, it has a roughly 10-year track record as a company. COVID-19 is definitely a curve ball that's causing some near-term headwinds, but if Broadmark's history as a private company is any guide, the dividend will be steady over time because its business tends to be steady over time.