Seven Hills Realty Trust - Earnings Call - Q1 2025

Executive Summary

• Q1 2025 distributable earnings (DE) were $0.34 per share (up sequentially from $0.33), driven by solid loan performance and two student housing originations; GAAP EPS was $0.30, and all loans were current with no nonaccruals.
• Portfolio credit quality improved (weighted average risk rating 2.9 vs 3.1 in Q4) and office exposure declined to 25% from 27% at year-end; liquidity remained ample with $41.6M cash and $298M of unused capacity and leverage at 1.6x debt/equity.
• Management guided Q2 DE to $0.29–$0.31 per share and said the Board will evaluate the dividend’s sustainability given lower benchmark rates and compressed net interest margins (NIM) on new originations; a $28M industrial loan is expected to close in Q2.
• Stock reaction catalysts: near‑term pressure from lower Q2 guidance and potential dividend reset vs. offsets from clean credit, improving risk metrics, and pipeline conversion (including expected Q2 closing).

What Went Well and What Went Wrong

What Went Well

• Portfolio performance and credit: “all loans…current and performing with no nonaccrual loans,” and risk rating improved to 2.9 from 3.1 QoQ, underscoring borrower support and asset quality.
• Originations momentum in resilient segments: closed two student housing loans ($31.2M San Marcos at S+3.25% all‑in S+3.68%; $18.5M Waco at S+3.35% all‑in S+3.75%) and highlighted robust pipeline.
• Liquidity and funding: $41.6M cash, $298M unused capacity; weighted average borrowing cost about SOFR+2.21%, with lenders supportive and borrowing costs targeted near SOFR+~2% on new deals.

What Went Wrong

• Margin pressure: management highlighted “continued compression of net interest margins” and the headwind from lower index rates (Q1 average SOFR 4.31% vs 4.64% in Q4) which reduced DE sequentially by ~$0.02 per share headwind in the bridge.
• Lower near‑term outlook: Q2 DEPS guided to $0.29–$0.31 (below Q1’s $0.34) as older, higher‑spread loans repay and redeploy at tighter spreads.
• Dividend risk rising: quarterly DE payout ratio was 103% and the Board will “continue to evaluate” the dividend to ensure sustainability given the expected headwinds.

Transcript

Operator (participant)

Good morning and welcome to Seven Hills Realty Trust's Q1 2025 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. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the call over to Matt Murphy, Manager of Investor Relations. Please go ahead.

Matt Murphy (Manager of Investor Relations)

Good morning. Joining me on today's call are Tom Lorenzini, President and Chief Investment Officer; Matt Brown, Chief Financial Officer and Treasurer; and Jared Lewis, Vice President. 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 29, 2025, 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 sevenre.com. With that, I will now turn the call over to Tom.

Thomas Lorenzini (President and CIO)

Thank you, Matt, and good morning, everyone. On today's call, I will begin with an overview of our first quarter performance and portfolio positioning, followed by some thoughts on the evolving rate environment and how it has impacted our outlook. I will then turn the call over to Jared to discuss our pipeline and broader market conditions, after which we will hear from Matt Brown, who I'm happy to introduce as our new Chief Financial Officer and Treasurer. Matt currently serves as a Senior Vice President at the RMR Group and brings nearly 20 years of accounting and commercial real estate finance experience to the team. Matt will review our financial results before we open the line for questions. For the first quarter, we reported distributable earnings of $0.34 per share, exceeding the high end of our guidance range.

These results reflect the continued strength and ongoing performance of our loan portfolio, supported by new loan production that helped mitigate the impact of lower interest rates on our loan book. We also declared and paid a quarterly dividend of $0.35 per share. As of March 31, all loans in our portfolio remain current and performing with no non-accrual loans. Our weighted average risk rating improved to 2.9, down from 3.1 last quarter. This improvement, coupled with the fact that we have no loans in default, reinforces the strong health of our portfolio and our borrowers' ability to execute on their business plans. As of quarter end, our portfolio totaled $691 million in commitments, comprised of 23 first mortgage loans with a weighted average all-in yield of 8.5%, a weighted average coupon of SOFR plus 3.69%, and a weighted average loan-to-value of 67% at close.

The portfolio had a weighted average maximum maturity of 2.6 years when including extension options and an average loan size of approximately $30 million. We ended the quarter with approximately $42 million in cash and $298 million in unused financing capacity, providing us with significant flexibility as we evaluate new investment opportunities. During the quarter, we closed two new student housing loans totaling approximately $50 million, a $31.2 million loan in San Marcos, Texas, and an $18.5 million loan in Waco, Texas. Both loans are secured by well-located, university-adjacent assets with experienced sponsors. These investments align with our focus on resilient sectors and disciplined credit selection, particularly in student housing, where we continue to see durable demand drivers and well-capitalized sponsors. Office exposure has declined to 25% of the portfolio in the first quarter, down from 27% at year-end.

While all our office loans remain current and supported by committed sponsors, we continue to actively reduce exposure to this sector in favor of asset classes such as multifamily, student housing, industrial, and necessity-based retail, which we believe offer stronger fundamentals and greater durability through various economic cycles. While our floating-rate portfolio has benefited from elevated interest rates over the past several quarters, we acknowledge that a lower rate environment going forward, combined with anticipated repayments, could put pressure on earnings over the balance of the year. In particular, several of the loans we expect to be repaid in 2025 were originated at spreads above today's market pricing, and as those proceeds are redeployed, we anticipate a more normalized earnings profile to emerge. However, it is important to note that the timing and nature of redeployment activity may influence how this transition plays out.

From our perspective, there are three key factors that will influence earnings throughout the balance of the year. First, the direction of interest rates. Any movement from the Fed will impact our whole loan returns and proportionately our borrowing costs, so this is something we're watching closely. Second, the pace at which we're able to originate new loans. We're seeing good pipeline activity, but timing can vary, and competitive dynamics are influencing how those opportunities are being priced. Third, our ability to structure deals that meet our underwriting standards and still deliver attractive risk-adjusted returns. While these variables remain largely market-driven, there are also factors within our control that may help offset earnings pressure. We have capacity to deploy capital efficiently, and as volatility causes some lenders to pause, we are beginning to see increased opportunities to originate high-quality loans at favorable pricing.

Our business model is well-positioned to respond to shifting market conditions, and our disciplined credit approach continues to earn the trust of sponsors seeking reliable execution. To summarize, while the environment remains uncertain, it is important to note that our more cautious outlook reflects the macro backdrop and not a deterioration in our portfolio's quality. Our loans remain fully performing, supported by stable property fundamentals and an improved risk profile. We remain confident that our selective approach, strong sponsor relationships, and current liquidity position us to navigate this evolving landscape and capitalize on opportunities as they arise. With that, I will now turn the call over to Jared for an overview of our pipeline and further insights into the current macro environment.

Jared Levin (VP)

Thanks, Tom. For the third quarter in a row, we saw market participants, borrowers, and lenders alike operate with a renewed sense of optimism. With seemingly greater clarity on the path of interest rates early in the quarter and increased competition amongst lenders for new loans, borrowers were able to make financing decisions with greater conviction. Our pipeline remained robust during the quarter, and we noticed an uptick in requests for new acquisitions, further signaling an improvement in overall market conditions. Over the past several weeks, however, we have seen a bit of a shift in market sentiment. After significant spread tightening early in the quarter driven by strong secondary market demand, particularly in the CRE, CLO, and CMBS sectors, we are starting to see signs of spreads widening, caused in part by recent tariff-related headlines and uncertainty surrounding the Fed's rate path.

While certain inflation figures have moved lower, the potential for tariffs to introduce new cost pressures has created a two-way scenario. On the one hand, slowing growth could prompt rate cuts, while on the other hand, potential tariff-driven inflation could create enough uncertainty to delay them. Despite the capital market volatility, there still exists a significant amount of 2021 and 2022 vintage loans scheduled to mature over the year, which will need to be addressed. Given these dynamics, we continue to see significant financing demand for floating-rate loans to refinance both bridge and construction debt that still need time for business plans to play out and properties to stabilize. In terms of property types, we continue to see strength in the multifamily sector, where the combination of elevated homeownership costs, limited new supply, and stable demand drivers continue to benefit the performance of existing assets.

We are also selectively pursuing industrial loans in markets with strong fundamentals, including a $28 million loan currently in diligence in the San Antonio area that we expect to close next month. This loan is secured by a newly constructed Class A distribution facility that includes a conservative reserve structure and lease-up assumptions. We also continue to evaluate retail and hospitality on a case-by-case basis. While these sectors carry more macro sensitivity, we believe necessity-based retail and select hospitality transactions can offer compelling risk-adjusted returns, particularly those with strong in-place cash flows, multiple demand drivers, and conservative loan structures. That said, while the lending markets remain active, particularly in the multifamily and industrial sectors, we have also started to see some lenders take pause, waiting for capital market volatilities to subside. We view this as an opportunity, especially given our clean balance sheet and available borrowing capacity.

To that end, we are evaluating a number of opportunities and remain focused on disciplined credit selection with an emphasis on well-capitalized sponsors and markets that continue to demonstrate strong underlying fundamentals. We believe our selective approach positions us well to take advantage of dislocations as they arise. With that, I'll turn the call over to Matt Brown for a review of our financial results.

Matthew Brown (CFO and Treasurer)

Thank you, Jared, and good morning, everyone. Yesterday, we reported first quarter distributable earnings of $5 million, or $0.34 per share, exceeding our guidance range for the quarter. The beat to guidance was driven by net earnings from loans and the revenue from the one property that we owned. Earlier this month, we declared a quarterly dividend of $0.35 per share. Our CECL Reserve remains modest at 130 basis points of our total loan commitments as of March 31, compared to 140 basis points as of December 31. The $153,000 reserve reversal was primarily due to improved performance at certain of the collateral assets underlying our loans. We do not have any collateral-dependent loans or loans with specific reserves. We ended the quarter with $42 million of cash on hand and a weighted average borrowing rate of SOFR plus 221 basis points. Total debt to equity remained at 1.6 times.

We believe that our conservative leverage and available borrowing capacity provide us with a strong opportunity to originate a CRE of loans. Turning to our outlook and guidance, while our loan portfolio continues to perform, supported by an improvement to our conservative overall risk rating of 2.9, declining benchmark interest rates and compressed net interest margins on loan originations could put pressure on earnings as certain of our older vintage loans with higher net interest margins are expected to be repaid this year. As such, our Board of Trustees will continue to evaluate our dividend rate to ensure it is at a sustainable level. Based on current expectations for loan originations and repayments, including loan repayments that may exceed originations during the quarter, we expect second quarter distributable earnings to be in the range of $0.29-$0.31 per share.

As Tom and Jared discussed, we have a robust pipeline, including a $28 million loan currently in diligence that we expect to close later in the second quarter. Before turning the call over to questions, I want to highlight that we have added three new slides to our earnings presentation to further illustrate our earnings trends from Q4 to Q1, as well as trends in net interest rate spreads and leverage. These new slides can be found on pages six to eight in our earnings presentation. That concludes our prepared remarks. Operator, please open the line for questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you'd like 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 Jason Weaver with JonesTrading. Please go ahead.

Jason Weaver (Analyst)

Hi guys, good morning. Thanks for taking my question. I know we've discussed the tightness in originations before making this less of an issue, but can you comment on any discussions with your lenders, how they've gone thus far, any sense of trepidation there all the way into April?

Jared Levin (VP)

Hi Jason, this is Jared. We've had great conversations with our lenders. They've all been pretty supportive of our business. We've evaluated a lot of new opportunities over the quarter, and we work closely with them to evaluate each opportunity, and they've been really helpful in helping us price credit. We haven't seen a lot of movement from them. We are hearing that secondary market spreads are widening a little bit, but to the extent that we've been able to hold our borrowing costs steady, they've been pretty supportive of doing that.

Jason Weaver (Analyst)

Got it. And that all in borrowing costs of SOFR plus, I think you said $269, has that remained relatively consistent to date?

Jared Levin (VP)

No. That reflects the overarching portfolio, but of late, we've seen borrowing costs come down commensurate with where spreads were in the first quarter. We're targeting and underwriting borrowing costs somewhere in the SOFR plus 2% range.

Jason Weaver (Analyst)

Got it. If I could just do one more, maybe for Tom. You mentioned earnings depending on your ability to originate within your own underwriting standards. Can you speak a bit more to that? Are you modifying your underwriting approach in any material way?

Thomas Lorenzini (President and CIO)

No, we are not modifying our approach. The comment really refers to, in the first quarter, things got pretty heated from a competitive standpoint, and it's really about maintaining the credit underwriting and what we've been doing historically, and not giving in to weaker credit underwriting standards.

Jason Weaver (Analyst)

Got it. Thanks for that clarification. Better than just blindly pursuing market share. Okay, that's been very helpful. Thank you, guys.

Jared Levin (VP)

Thank you.

Operator (participant)

Again, if you have a question, please press star then one. Our next question comes from Chris Miller with Citizens Capital Markets. Please go ahead.

Chris Muller (Analyst)

Hey guys, thanks for taking the questions, and congrats on a nice start to 2025. I wanted to start on credit. You guys have had great credit performance across the portfolio, even with a good chunk of the portfolio in office loans. I guess, is there anything that you can point to, to that success? Is it your strict underwriting standards or geographies or loan sizings or even the type of borrowers you work with? Just anything that would help us drill down there, I think, would be helpful.

Thomas Lorenzini (President and CIO)

I think you touched on a couple of them right there in the question. It's certainly borrower and sponsorship is critical, and that we believe is a reflection of our underwriting, making sure that we are underwriting and lending to sponsors that certainly have the capability to solve problems should they arrive. As you've seen in most of our office loans, we've had to modify several of them, right, with sponsorship coming in with fresh cash as an effort to support the asset, whether that just be for interest carry or for TIs for new tenants or what have you. When sponsorship's willing to put in additional capital, that says a lot. The second thing I would point to there really is, I believe it is our underwriting and our asset management.

We get accused of asking a lot of questions and being very diligent by our borrowers, which I think they appreciate, but we certainly want to make sure that we drill down, we understand the asset, we understand the market, and again, we're really relying heavily on sponsorship and their experience. I think it's a function of the fact that we're choosing the right sponsors and we're diligenting them appropriately.

Chris Muller (Analyst)

Got it. That's helpful. It's nice to see the new lending continue. You guys have been able to kind of do that at a slow, steady pace. I guess that was prior to some of the market disruptions in early April. Have you seen much of an impact on your existing pipeline there? Do you guys have any expectations on portfolio growth for the balance of this year?

Jared Levin (VP)

We have not really seen any change in the pipeline as a result of the volatility in April. It has really been more capital markets volatility, interest rates, bond spreads, etc. Borrowers still have a lot of loans that they need to refinance this year, and I do not think that is going to change. Borrowers are certainly being more thoughtful about whether they are going to go floating rate or fixed rate today. It is just a little bit more challenging for them, but the pipeline still remains pretty robust, I would say. No issues there. In terms of the pipeline for the rest of the year, I mean, we are underwriting two loans right now.

One is in diligence for about $28 million. We have another that we are negotiating heavily, just under $20 million that we hope to sign up and have flows by the end of the quarter.

Through the end of the year, I think the pace of the loans rolling off the books will dictate what new originations we put on.

Chris Muller (Analyst)

Got it. That's helpful. If I could just squeeze in one last quick one. Do you guys have any updates you could share on the Yardley office? Should we expect the sale for that at some point in 2025?

Jared Levin (VP)

Right now, the plan for Yardley really is probably to remain on the books through 2025, and then we'll evaluate that with the board towards the end of the year. It currently is producing and contributing to our DE. I mean, I think it was two and a half cents or almost three cents in this quarter. So we're happy having it contribute to earnings as well. There's no rush there. I think we've got a WALT on that property of almost five years or six years. The rent roll there is stable. The management team is doing a great job, and there has been activity for touring for some of the vacant space there. We anticipate there might even be another lease sign here by the end of the year if all goes well.

Chris Muller (Analyst)

Got it. That's a great position to be in. Thanks for taking the questions, and congrats on a good start to the year.

Jared Levin (VP)

Thank you.

Operator (participant)

Your next question comes from Jason Stewart with Janney Montgomery. Please go ahead.

Jason Stewart (Analyst)

All right. Thank you for taking the questions. Just a couple more on the portfolio. There's a handful of initial maturities in Q2 2025. Is your expectation that these pay off or that they're extended? Maybe specifically, if you could give us an update on Downers Grove there since I think we've already passed the initial maturity date.

Jared Levin (VP)

Yeah, sure. For Downers Grove, the loan was extended through May 2023. We are working on a longer-term extension there with sponsorship. We anticipate that'll probably be a 12-month extension, and concurrent with that would be a paid-out of some sort. That property is performing quite well. They were in the market to refinance. There was a tenant there that went bankrupt, which delayed things. They have been a great sponsor to work with. As I said, the anticipation is that we are going to finalize a longer-term extension with a material paid-out maybe of upwards of $3 million.

Jason Stewart (Analyst)

Okay. That's helpful. I think you have retail. There's a multi. There's a couple of other maturities in Q2.

Jared Levin (VP)

Yeah. Sure. For Q2, we have five loans that could potentially repay. We have two multifamily projects that are under application. We also have an industrial asset that is under application, a retail asset that is, and two retail. One retail asset under application and another retail asset that's under PSA for sale. We anticipate a total of five assets for potentially up to about $145 million in total commitments could prepay at the end of Q2, bleeding maybe into early Q3. It's really a function of the markets we're in today, right? While several of those are going to be refinances, we're certainly sensitive to kind of what's happening in the market. Should a lender on a refinance decide to change terms, they might come back to us for an extension rather than refi. We're watching that closely.

Jason Stewart (Analyst)

Got it. Okay. Just pulling way up on the ROE of new origination activity, if you could just give us a sense of if this whole portfolio transitioned to tomorrow, what would you expect the gross ROEs to look like on new origination activity?

Jared Levin (VP)

For the incremental investments that we're seeing today, given the deals that we're pricing, I mean, we're seeing low teens ROE on those investments given our borrowing costs. That's what we alluded to earlier, being really thoughtful about as loans mature and as we put new assets on the books, how to maximize that ROE, obviously, without sort of sacrificing credit. It's kind of a good position to be in, I guess. I'd say low teens is what we're targeting right now.

Jason Stewart (Analyst)

Okay. Just one last one as we think about the dividend and timing. Obviously, the payouts, I get how they could move around a little bit. How are you thinking about timing of evaluating the dividend if you're thinking about this? I mean, are you waiting for loans to pay off to make an adjustment to the new environment, or are you thinking about how are you thinking about that in terms of timing?

Thomas Lorenzini (President and CIO)

Sure. It's a good question. It's something that our board of trustees discusses each quarter, and that's in conjunction with our overall forecast and our expectations around repayments and redeployment. It's important to reiterate that our whole loan portfolio is performing and very strong, but we are expecting certain headwinds from a market standpoint. With the repayments that Tom talked through, those are at higher net interest spreads than what we're originating. We'll continue to evaluate it each quarter.

Jason Stewart (Analyst)

Okay. All right. Thanks for taking the questions. Appreciate it, guys.

Operator (participant)

This concludes our question-and-answer session. I would like to turn the conference back over to Tom Lorenzini, President and Chief Investment Officer, for any closing remarks.

Thomas Lorenzini (President and CIO)

Thanks, everyone, for joining our call today. We look forward to seeing many of you at the upcoming NAREIT conference in June. Please reach out to Investor Relations if you are interested in scheduling a meeting with Seven Hills. Operator, that concludes our call. Thank you.

Operator (participant)

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