Ares Commercial Stock: 9.3% return and book value discount (NYSE: ACRE)

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Ares Commercial Real Estate Corporation (NYSE:ACRE) is a value-priced, first mortgage trust with a significant origination operation. Due to its large assets in variable rate commercial first mortgages, the trust has a well-covered dividend and rising interest rates.

The stock is trading at a discount and the company benefits from its partnership with Ares Management Corporation.

Origination activity focused on senior loans

Ares Commercial specializes in originating senior loans in the US commercial real estate market. The trust benefits from its partnership with Ares Management Corporation, a global investment manager with $325 billion in assets under management and a $46 billion global real estate asset platform. Ares Management Corporation sponsored Ares Commercial.

Assets under management

Assets under management (Ares Commercial R/E Corp)

The trust typically issues senior commercial loans in the industrial, multi-family, hotel, office and self-storage sectors, but it also has exposure to the less transparent student housing and residential sectors. Ares Commercial typically invests in senior (secured) loans with a target investment size of $10 million to $250 million, with short term loans (3 years) and floating rates that change with changing rates of interest.

Target investments and property type

Target investments and property type (Ares Commercial R/E Corp)

The trust has amassed a $2.4 billion loan portfolio consisting of 77 major loans. Additionally, 99% of all loans have prime characteristics, meaning they are heavily backed by cash assets.

Offices are Ares Commercial’s largest investment category, accounting for 35% of the trust’s portfolio. Multi-family loans make up 13% of the trust’s loan exposure, while mixed-use loans make up 12%, hotels make up 12%, industrial accounts 10%, self-storage accounts 9%, residential accounts 6% and students housing represents 3%.

Loan portfolio positioning

Loan portfolio positioning (Ares Commercial R/E Corp)

Ares Commercial’s net interest margin generates the majority of its revenue, with the remainder coming from owned real estate. Net interest margin reflects interest income from Ares Commercial’s large senior loan portfolio, which is the Trust’s core business.

Net interest margin

Net interest margin (Ares Commercial R/E Corp)

Rising interest rates

Ares Commercial issues Senior Loans, the majority of which are floating rate. With floating rates on 98% of loans originated, the trust is well positioned for an increase in interest rates.

Management forecasts that a 2% increase in benchmark interest rates will result in an annual increase in net earnings of $0.24 per share.

Given that the central bank has signaled that it intends to begin an aggressive cycle of raising interest rates to manage inflation, Ares Commercial’s earnings are expected to rise as interest rates rise. interest increases. Due to Ares Commercial’s sensitivity to interest rates, an investment in the trust can also function as an inflation hedge.

Sensitivity to interest rates

Sensitivity to interest rates (Ares Commercial R/E Corp)

The dividend is well covered

Ares Commercial pays a quarterly base dividend of $0.33 per share, which is currently supplemented by a special dividend of $0.02 per share.

Over the past year, the total quarterly dividend payout has been $0.35 per share, and Ares Commercial is covering its dividend with distributable earnings. In fact, Ares Capital has consistently covered its dividend payouts with distributable income over the past five years. Ares Commercial’s most recent dividend coverage ratio, based on the trailing twelve months, was 1.1x.

Full dividend coverage

Full dividend coverage (Ares Commercial R/E Corp)

Sell ​​at a discount to book value

Shares of Ares Commercial trade at a 3% discount to book value, while other industry trusts, such as Starwood Property Trust (STWD) and Blackstone Mortgage Trust (BXMT), trade at P/B multiples greater than 1x, implying premiums. I don’t think there is a clear reason why Ares Commercial is selling at a discount, especially when Ares Commercial’s portfolio is heavy with senior (secured) loans.

Why Ares Commercial Might See a Lower Share Price

Ares Commercial’s ability to grow its revenue depends on the health of its origination business, which depends on the strength of the commercial real estate market in the United States.

Ares Commercial faces risks related to declining demand for new creations during a recession, as well as debtors defaulting on their financial responsibilities. The trust’s heavy exposure to office properties could be a concern for Ares Commercial, as this industry is notoriously cyclical.

My conclusion

Ares Commercial’s strong 9.3% return is covered by distributable income and has continuously covered its dividend payout for the past five years.

Because loss ratios on highly secured loans are relatively low, focusing on senior loans protects shareholders in the event of a housing downturn.

Additionally, Ares Commercial’s high floating rate percentage of 98% offers rising interest rates, implying that the trust is ready to increase its income when interest rates rise.

Dividend investors looking for substantial dividend income should consider Ares Commercial, which is trading at a discount to book value.

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