Seven Hills Realty Trust - Q1 2024

Transcript

Operator (participant)

Good morning, and welcome to the Seven Hills Realty Trust First Quarter 2024 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the call over to Stephen Colbert, Director of Investor Relations. Please go ahead.

Stephen Colbert (Head of Investor Relations)

Good morning. Joining me on today's call are Tom Lorenzini, President and Chief Investment Officer, and Fernando Diaz, Chief Financial Officer and Treasurer. Today's call includes a presentation by management, followed by a question and answer session with analysts. Please note that the recording, retransmission, and transcription of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on Seven Hills' beliefs and expectations as of today, April 30, 2024, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call.

Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP financial numbers during this call, including distributable earnings and distributable earnings per share. A reconciliation of GAAP to non-GAAP financial measures can be found in our earnings release presentation, which can be found on our website at sevnreit.com. With that, I will turn the call over to Tom.

Tom Lorenzini (President and CIO)

Thanks, Stephen. Good morning, everyone, and thank you for joining our call today. Last night, we reported strong first quarter results, highlighted by distributable earnings per share that were above the high end of our guidance range. The continued strength and stability of Seven Hills' investment portfolio once again helped to deliver positive total shareholder returns that exceeded our Nareit industry benchmark for the quarter. We believe this ongoing outperformance serves as a testament to the strength of our loan book and our disciplined underwriting, originations, and asset management teams. With ample liquidity on hand, we look forward to continuing to build on our momentum throughout 2024. Turning to a few highlights from the first quarter. We delivered distributable earnings per share of $0.38, exceeding our $0.35 per share quarterly dividend by 9%.

The credit profile of our loan portfolio remains stable, with an overall average risk rating of 3, with no loans in default and no non-accrual loans. We received over $40 million of loan payoffs, demonstrating the continued ability of our well-capitalized sponsors to execute on their business plans in today's market. We delivered total shareholder returns that outperformed the industry benchmark by more than 7 percentage points, equating to cumulative outperformance of more than 60% since the beginning of 2022. From a macro perspective, the U.S. economy has remained resilient amid a backdrop of relatively strong economic data and inflation readings above the Federal Reserve's comfort level. As a result, expectations for interest rate cuts have shifted and are now weighted towards the back half of this year.

While we believe that lower interest rates will ultimately create a more favorable environment for real estate transactions and result in increased lending opportunities, we are confident in our current production pipeline to provide a steady flow of attractive investment opportunities to further expand our loan book this year. Turning to our first quarter portfolio activity. Our conservatively underwritten portfolio continues to experience repayments across various property types. During the quarter, we received three loan payoffs, including one office, one retail, and one industrial property, for a total of $40.4 million. We did not close on any new loans during the first quarter, which is traditionally a slower period of the year.

Post quarter end, however, on April 25, we closed a multifamily loan with a total commitment of $17.8 million, with a coupon of SOFR + 315 basis points for an all-in yield of 9% when including loan fees. Turning to our loan book as of March 31. Seven Hills' portfolio remained 100% invested in floating rate loans and consisted of 21 first mortgages with an average loan size of $30 million and total commitments of nearly $630 million, down approximately 6% or $40 million from last quarter, while future fundings remain consistent at only about 6% of our total commitments. Our investments have a weighted average coupon, 9.1%, and an all-in yield of 9.6%.

In aggregate, the portfolio has a weighted average maximum maturity of 2.8 years when including extension options and a stable overall credit profile with an average risk rating of 3 and a loan-to-value at close of 68%. We continue to make progress diversifying our loan book. As of quarter end, multifamily was our largest property type at 35%. Our office exposure has declined to 28% compared to 40% a year ago. The balance of our portfolio is comprised of retail, hospitality, self-storage, and industrial loans. In terms of portfolio vintage, after the repayments we received during the first quarter, Seven Hills' portfolio now consists entirely of loans that were originated subsequent to the onset of the pandemic. From a capital perspective, our lending partners remain very supportive of our business.

In aggregate, our four secured financing facilities provide us with nearly $700 million in borrowing capacity, and we had a weighted average borrowing rate of SOFR +285 basis points at the end of the quarter. Turning to our active deal pipeline, we continue to see a steady flow of deals with over $600 million of prospective lending opportunities in various stages of our screening and diligence process, consisting of acquisition and refinancing requests for industrial, multifamily, self-storage, retail, and hospitality properties, including one loan for $23.8 million currently under application and in diligence and expected to close within the next 45 days. In closing, our portfolio and overall credit performance remains strong, and our business continues to deliver solid results.

While interest rates are likely to remain higher for longer, we believe we are well positioned to accelerate loan production this year, selecting the most compelling investment opportunities for our portfolio and continue to generate attractive returns for our shareholders. With that, I will now turn the call over to Fernando.

Fernando Diaz (CFO)

Thank you, Tom, and good morning. Yesterday afternoon, we reported first quarter 2024 distributable earnings, or DE, of $5.6 million, or $0.38 per share, which was $0.01 above the high end of our guidance range, primarily due to the timing of loan repayments during the quarter. Our run rate earnings over the last few quarters have comfortably exceeded our dividend level. In mid-April, we declared our regular quarterly dividend to shareholders of $0.35 per share, payable on May 16th, which our first quarter DE covered by approximately 109%. On an annualized basis, our dividend equates to a yield of approximately 11% based on yesterday's closing stock price.

Our seasonal reserve remains modest at 100 basis points of our total loan commitments as of March thirty-first, and all loans remain current on debt service, and we have no non-accrual loans. We remain focused on further diversifying our portfolio into real estate sectors with fundamentals we deem to be more attractive and have reduced our office exposure to 28% as of quarter end, compared to 40% in the first quarter of 2023. As a reminder, to help protect us against investment losses, we structure all of our loans with risk mitigation mechanisms such as cash flow sweeps, interest reserves, and rebalancing requirements, and we do not have any collateral-dependent loans or loans with specific reserves. In the first quarter, Seven Hills maintained its conservative leverage metrics and continues to have substantial liquidity.

We ended the quarter with $93 million of cash on hand and $272 million of reinvestment capacity across our 4 secured financing facilities. Total debt to equity decreased to 1.6x from 1.7x at the end of the previous quarter, primarily due to the 3 loan repayments that Tom discussed. We believe that our conservative leverage and available borrowing capacity provide a strong opportunity to originate accretive loans that will benefit the company going forward. Turning to our outlook and guidance for the second quarter. We expect distributable earnings to be within a range of $0.35-$0.37 per share, which will continue to cover our quarterly dividend. This guidance reflects our recent origination and repayment activity and assumes flat G&A expenses and that interest rates will remain consistent with current levels.

That concludes our prepared remarks, and with that, operator, please open the lines for questions.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To ask a question, you may press star, then one on a touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Matthew Erdner with JonesTrading. Please go ahead.

Matthew Erdner (Director)

Hey, good morning, guys. Thanks for taking the question. Could you talk a little bit about the pipeline and, you know, what you guys are really looking for to accelerate that loan growth, whether it be, you know, specific property types, geographic regions? You know, and I guess how quickly do you think that you can scale up the portfolio to an optimal size?

Tom Lorenzini (President and CIO)

Thanks for the call. It's Tom here. So from a geographic region, certainly, you know, we lend nationwide, as you're aware. There's really you know that continues to be the focus, right? So we have not you know redlined any particular markets that you know that we're going to lend into. From a product standpoint, I would tell you that we're still very active in the multifamily sector. As I noted, we just closed a multifamily loan. We currently have under application right now and in diligence, a self-storage property that we're looking at on the West Coast. We expect that to close in the next 45 days or so.

Industrial still makes sense in certain locations, and hospitality, you know, we're seeing the hospitality perform very well right now, and, you know, we're looking at a few opportunities there as well. What we've modeled for production is about $175 million of loans for the year. I think we're projected to do 6 loans at about $28 million-$30 million apiece. And then from there, we could increase that depending on the velocity of repayments that we have. We do expect a couple repayments before the end of the year, yet, so, like, you know, maybe there's another $50 million-$80 million that comes back that we can reinvest.

But we see no reason why we can't hit our, our target right now of the six loans for the year of 2024.

Matthew Erdner (Director)

Awesome. Thank you for that. That's, that's good color there. And then I noticed a couple of the occupancies on the office, particularly the one in Dallas, ticked up to 73% from 67% quarter-over-quarter. Could you talk about what you're seeing, you know, in leasing in your guys' properties, and, you know, just the overall market there?

Tom Lorenzini (President and CIO)

Yeah. So the Dallas transaction, they did have some a modest uptick in leasing there. They actually changed their leasing team there as well, which has generated additional foot traffic and additional tours of the property. As far as what we're seeing in leasing, you know, for the one asset that we own, the Floral Vale transaction that you're aware of in Yardley, Pennsylvania, we've seen some good positive leasing momentum there as well. We've had numerous tours for our leasing brokers there, and we're looking at currently under an LOI for a modest increase in occupancy there with a new tenant that's moving into the space. So overall, office is difficult, as you're aware.

I think it really depends on the leasing team that you have there, and that if you have, you know, capitalized sponsors that are willing to contribute the cash necessary to for the TI spend and the commission spend, right, to attract those new tenants. So we are cautiously optimistic, I would say, on our office portfolio. Everybody is, you know, current on debt service. All the loans have available cash as needed for TIs, leasing, and for carry, if that's the case, so.

Matthew Erdner (Director)

Yeah. Well, that's great news. Thanks for answering the questions.

Tom Lorenzini (President and CIO)

Thank you.

Operator (participant)

Again, if you have a question, please press star then one. The next question comes from Chris Muller with Citizens JMP. Please go ahead.

Chris Muller (Director)

Hey, guys. Thanks for taking the questions. So I wanted to hit on the pipeline a little bit as well. So I think on the last call, you guys said there was, like, $750 million in the pipeline there. Can you talk about kind of the, the dynamics that are playing out there? Are loans falling out of the pipeline before reaching the finish line, or are you guys just not seeing loans you like there, or just maybe building some defensive or even opportunistic capital right now? Thanks.

Tom Lorenzini (President and CIO)

Yeah, Chris, I think it's a little bit of all of those things that you just mentioned. I think there's been... Going back a few months, right, I think the optimism in the market was, "Hey, the Fed's gonna lower rates.

Maybe now is the time I can entertain a refinance if I'm an existing borrower, get off my current loan, maybe ride the curve down and put some better financing in place. But so a good number of those transactions just didn't happen, right, because the messaging coming from the Fed and the economy in general just said, "Hey, look, we're gonna be at a higher interest rate period for a longer time." So I think it took a little bit of the wind out of the sails, if you will, for quite a few people that might have been looking to refinance.

The other thing that we're seeing, there's still in the market, you know, you have over-leveraged transactions that were written in 2021, maybe that are coming due, especially in the multifamily sector, where we're trying to be active, which are gonna require some cash in. So, you know, we'll often underwrite transactions that we want to, that we wanna go after, and there may be some cash required from the sponsorship to balance that out, and they're not willing to do that, so that transaction doesn't happen. The other dynamic that you have going on is there's just a lot of dry powder, I think, on the sidelines with a lot of lenders. So when you find a transaction that works, it's very competitive.

And we've seen spread compression, so we may find ourselves in situations where we certainly want the transaction, we're putting best foot forward, and somebody really just kinda comes in and almost buys the business, if you will, because they might be feeding a CLO or some other securitized execution, and they're willing to do it much cheaper than, you know, than we feel appropriate. So, there is flow out there. It's just... It's just a little more difficult to get it across the goal line right now.

Chris Muller (Director)

Got it. That's very helpful. And then changing gears a little bit here. So it looks like the purchase accretion discount should run out in the next maybe quarter or two. It looks like that added about $0.08 to revenues in the first quarter here. So I guess my question is, do you expect GAAP earnings to run below the dividend level, in the near term, and, we'll see some book value declined as a result of that?

Fernando Diaz (CFO)

Hey, Chris, this is Fernando. I'll take that. You know, we are expecting this accretion to run off by the third quarter. So it will be progressive. Second quarter and third quarter will be down, like I said. So, you know, we don't believe that's gonna be impacting that much in terms of the earnings. Obviously, we, you know, as we ramp up our production, as Tom alluded, that's gonna help us balance that as well.

Chris Muller (Director)

Got it. That's helpful. Thanks for taking the question.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Tom Lorenzini for any closing remarks.

Tom Lorenzini (President and CIO)

Thanks, everyone, for joining us today. We look forward to seeing many of you at the Nareit Conference in New York City in June. Operator, this concludes our call today.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.