Q1 2024 Seven Hills Realty Trust Earnings Call

Participants

Stephen Colbert; Director, Investor Relations; Seven Hills Realty Trust

Tom Lorenzini; President & Chief Investment Officer; Seven Hills Realty Trust

Fernando Diaz; Chief Financial Officer, Treasurer; Seven Hills Realty Trust

Matthew Erdner; Analyst; JonesTrading Institutional Services LLC

Chris Muller; Analyst; Citizens JMP Securities, LLC

Presentation

Operator

Good morning, and welcome to the Seven Hills Realty Trust first-quarter 2024 financial results conference call. (Operator Instructions) 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

Good morning, and joining me on today's call are Tom Lorenzini, the 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 Hill's 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'll 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.
And with that, I will turn the call over to Tom.

Tom Lorenzini

Thanks, Stephen. Good morning, everyone. Thank you for joining the 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 Southern Hills investment portfolio once again helped to deliver positive total shareholder returns that exceeded our Navy 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.
Before 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 three with no loans in default and no nonaccrual 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, and we delivered total shareholder return but 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 US 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, our 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 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 call the multifamily loan with a total commitment of $17.8 million with a coupon so far was 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 remains 100% invested in floating rate loans and consistent with 22st 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 remained consistent at only about 6% of our total commitments.
Our investments have a weighted average coupon of 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 three 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. And 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 of for secured financing facilities provide us with nearly $700 million in borrowing capacity. And we had a weighted average borrowing rate of sulfur plus 218 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 screen 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

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 16, which our first quarter the 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 CECL reserve remains modest at 100 basis points of our total loan commitments as of March 31, and all loans remained current on debt service, and we have no nonaccrual 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 of Seven Hills, maintaining 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 four secured financing facilities. Total debt to equity decreased to 1.6 times from 1.7 times at the end of the previous quarter, primarily due to the three 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 to $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.

Question and Answer Session

Operator

Thank you. We will now begin the question-and-answer session to ask a question. (Operator Instructions)
Matthew Erdner, JonesTrading.

Matthew Erdner

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

Tom Lorenzini

Yes. Al, thanks for the call. It's Tom here. So from a geographic region, certainly we went nationwide. As you're aware, there's really that continues to be the focus, right? So we've not of Redland any particular markets that we feel 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 on, as I noted, we just closed the multi-family loan.
We currently have under application right now on 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 on. Industrial still makes sense in certain locations and hospitality, we're seeing hospitality performed very well right now, and we're looking at a few opportunities there as well.
What we model for production is about $175 million of loans for the year. I think we're projected to do six loans at about $28 million to $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 of repayments that come in in the US before the end of the year yet. So I don't know maybe there's another $50 million to $80 million that comes back that we can reinvest on, but we see no reason why we can't hit our target right now of the six loans on for the year of '24.

Matthew Erdner

Awesome. Thank you for that. And 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. Because you talk about what you're saying, you know, when leasing in your guys' US properties and they just the overall market.

Tom Lorenzini

Yes. So the Dallas transaction arm, they were 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 for the one asset that we own, the floral sales transaction that you're aware of in Yardley, Pennsylvania, some we've seen some of the positive leasing momentum there as well. We had numerous tours for our leasing brokers there, and we're looking at currently under an ally for up a modest increase in occupancy there with a new tenant that's moved into the space.
So overall, our business difficult, as you're aware on, I think it really depends on the leasing team that you have there and that you have capitalized sponsors that are willing to contribute the cash necessary to on the TI spend and the commission spend right to non to attract those tenants. So we are cautiously optimistic. I would say on the on our on our on all the portfolio on everybody is current on debt service. All the loans are on available cash as needed for TI's leasing and for carry, if that's the case.

Matthew Erdner

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

Tom Lorenzini

Thank you.

Operator

(Operator Instructions)
Chris Muller, Citizens JMP.

Chris Muller

Thanks for taking the questions. I want 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 dynamics that are playing out there are loans falling out the pipeline before reaching the finish line. Are you guys just not seeing loans you like there are just maybe building some defensive or even opportunistic capital right now?

Tom Lorenzini

Yes, Chris, I think it's a little bit of all of those things that you just mentioned. There's been going back a few months, right? I think the optimism in the market was, hey, the Fed's going to lower rates. Maybe now is the time I can entertain a refinance of an existing borrower, get off the current loan, maybe ride the curve down, it puts a better financing in place.
So a good number of those transactions that didn't happen, right, because the messaging coming from the Fed and the economy generally is that, hey, look, we're going to be at a higher interest rate period for a longer time. So I think it took a little bit about window sales. If you will for quite a few people that might have been looking to refinance.
The other thing that we're seeing some there's still in the market, you have over-leveraged transactions that were written in 2021, maybe that are coming due on, especially in the multi family sector world, where we're trying to be active, which are going to require some cash. And so on will off and underwrite transactions that we want to them that we want to go after. And there may be some cash required from the sponsorship to balance that out in 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 on and we've seen spread compression. So we may find ourselves in situations where we certainly want the transaction will put the best foot forward.
And somebody really just kind of comes in and almost buys the business, if you will, because they might be speaking to Seattle or some other securitized execution and they're willing to do it much cheaper than we feel is appropriate. So there is flow out there and it's just a little more difficult to get it across the goal line right now.

Chris Muller

Yeah, 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, you'll take 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 I will see some book value decline as a result of that.

Fernando Diaz

Hi Chris, this is Fernando, I'll take that up. We are expecting this accretion to run off by the third quarter. So it will be progressive second quarter and third quarter will be done, like I said. So we don't believe that's going to be impacting us that much. In terms of the earnings, obviously, we as we ramp up our production, as Tom alluded, that's going to help us balance that as well.

Chris Muller

That's helpful. Thanks for taking the question.

Operator

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

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

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