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Apollo Commercial Real Estate Finance: Is This 10.3%-Yielding REIT A Buy Right Now?

Feb. 18, 2019 2:33 PM • ari

This article is exclusive for subscribers.

Summary

Apollo Commercial Real Estate Finance released fourth quarter results last week.

The commercial mortgage REIT earned its full dividend payout with operating earnings.

Apollo Commercial Real Estate Finance could see an improvement in distribution coverage on the back of rising NII.

An investment in ARI yields 10.3 percent.

Shares are affordable, but should you buy?

Apollo Commercial Real Estate Finance, Inc. (NYSE:ARI) is a high-yield commercial mortgage REIT for investors with an above-average risk tolerance. Apollo Commercial Real Estate Finance saw strong origination activity in the last quarter of 2018, and the company retains net interest income upside in a rising rate environment. Though Apollo Commercial Real Estate Finance covered its dividend with operating earnings in the last quarter, the margin of dividend safety is very thin. Shares are affordable, and an investment in ARI yields 10.3 percent. What should investors do now?

Apollo Commercial Real Estate Finance – Portfolio Overview

Apollo Commercial Real Estate Finance has a large and growing commercial real estate loan portfolio. At the end of the December quarter, 79 percent of the REIT’s investments were first mortgages (which tend to be floating rate), and 21 percent were subordinated loans. The loan portfolio itself was valued at $4.9 billion and consisted of 69 loans with a weighted average remaining term of 2.8 years.

The big deal with commercial mortgage REITs is that they have significant positive interest rate sensitivity: The higher interest rates climb, the bigger the earnings impact for Apollo Commercial Real Estate Finance, for instance.

A 100 percent of Apollo Commercial Real Estate Finance’s new originations in the fourth quarter were floating rate.

Source: Apollo Commercial Real Estate Finance

Apollo Commercial Real Estate Finance, therefore, has considerable net interest income upside in a rising rate environment. According to management estimates, a one percent increase in LIBOR is expected to boost the REIT’s net interest income by $0.20/share annually going forward.

Source: Apollo Commercial Real Estate Finance

Distribution Coverage

Apollo Commercial Real Estate Finance doesn’t have the best dividend coverage stats in the sector, to be honest, which is why I continue to prefer Starwood Property Trust (STWD), Blackstone Mortgage Trust (BXMT) and Ladder Capital Corp. (LADR) over ARI. That being said, though, Apollo fully earned its $0.46/share quarterly dividend payout in the fourth quarter.

In the last nine quarters, Apollo Commercial Real Estate Finance pulled in an average of $0.41/share in operating earnings compared to a stable $0.46/share dividend.

Here are Apollo’s major dividend coverage stats.

Source: Achilles Research

Apollo Commercial Real Estate Finance’s shares currently sell for

9.7x Q4-2018 run rate operating earnings, which is a sensible multiple.

And, here’s how ARI compares against other commercial mortgage REITs in the sector based on price-to-book-ratio.

Data by YCharts

Risk Factors Investors Need To Consider

Apollo Commercial Real Estate Finance is vulnerable to two developments:

1. A deterioration of fundamentals in the commercial real estate market, which in turn would most likely lead to lower originations and lower (operating) earnings;

2. A decrease in interest rates which would greatly limit the REIT’s net interest income upside.

In both cases, pressure on Apollo Commercial Real Estate Finance’s distribution coverage stats could build and result in a dividend adjustment. I consider ARI to have a higher dividend adjustment risk than its peers due to the REIT’s narrow margin of dividend safety.

Your Takeaway

Apollo Commercial Real Estate Finance is a high-yield income vehicle suitable only for investors with an above-average risk tolerance and that want to bet on a strong commercial real estate market going forward. Apollo Commercial Real Estate Finance just about covers its dividend with operating earnings, but if interest rates continue to go up in 2019, the REIT’s dividend coverage stats could improve. In any case, investors may want to limit their exposure to ARI to 1-2 percent of total portfolio assets.


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SOURCE: SOURCE: NEF6.COM
http://seekingalpha.com/article/4241913-apollo-commercial-real-estate-finance-10_3-percent-yielding-reit-buy-right-now

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