In the immortal words of How I Met Your Mother's Barney Stinson, "New is always better." And in this case, I think he's right, because on December 15, 2014, special finance company, Ladder Capital (NYSE:LADR), became one of the most recent companies to announce its intention to become a real estate investment trust, retroactive to Jan. 1, 2015. The company's new look should come with two immediate benefits for shareholders.
First, REITs are required by law to payout 90% of their taxable income. That means Ladder Capital will go from paying no dividend to a hefty dividend almost overnight. In fact, compared to similar companies – like Starwood Property Trust and Blackstone Mortgage Trust – it's possible we could see a yield in the 4% to 6% range. Second, in exchange for paying out nearly all of their income to shareholders, REITs receive significant tax breaks. All things being equal, the lower tax rate should boost earnings per share.
Beyond tax breaks and yield, however, I think there are three big reasons investors should be paying close attention to this REIT newcomer.
3. Diverse income stream
A versatile business can make money in a number of ways, and Ladder Capital is no exception.
The company's primary business is making commercial real estate loans, and those assets are diversified among loans to property owners primarily for hotels, office, retail, or multifamily properties. Once a loan is made, Ladder Capital can sell it and earn a fee, or hold the loan on its balance sheet and collect interest.
As shown in the chart above, Ladder also invests in commercial mortgage-backed securities, or CMBS, physical real estate, and subordinate debt. Commercial mortgage-backed securities are normally several commercial loans packaged together into a bond, this makes them safer than an individual loan and easier to buy and sell. Ladder's real estate assets include 32 retail properties, four office properties, and two condominiums from which it collects rent. And lastly, the company owns subordinate debt, which is, essentially, a riskier piece of a commercial loan.
Ultimately, Ladder Capital's range of assets helps to spread out the company's risk, as well as provide incredible opportunities for growth.
2. Well-covered debt
Real estate companies, especially REITs, will borrow to finance their investments. The key for investors is to make sure the company is not overextending itself or taking on more debt than it can easily pay off. One way to check is through the coverage ratio.
|Company||Earnings before interest and taxes||Divided by||Interest expense||Coverage ratio|
|Starwood Property Trust||$539,000,000||/||$115,000,000||4.7|
|Blackstone Mortgage Trust||$123,000,000||/||$48,000,000||2.6|
Ladder Capital only went public in February 2014, so the sample size is admittedly small. However, as a rule of thumb, I think that a coverage ratio below two can signal the company will struggle to pay its debt. With a ratio of three, Ladder is earning more than enough to manage its debt.
1. Internally managed
Perhaps more than well-covered debt and a diverse income stream, a REIT stands out for having internal management. This is because many of today's REITs, including Starwood Property and Blackstone Mortgage, opt for external management.
Essentially, instead of working inside the company, the external manager is a separate entity that charges a fee -- normally a percentage of assets under management or shareholders' equity -- for making investment decisions.
My issue with an external manager is that it does not align the interests of shareholders with management. Starwood Property discussed this at length in its 2013 annual filings:
We pay our Manager substantial base management fees regardless of the performance of our portfolio. Our Manager's entitlement to a base management fee, which is not based upon performance metrics or goals, might reduce its incentive to devote its time and effort to seeking investments that provide attractive risk-adjusted returns for our portfolio.
Ladder Capital and other internally managed companies are paid based on performance. That means if management is getting rewarded, so are shareholders. I don't know about you, but that just feels right.
Watching and waiting
As mentioned earlier, REITs pay out 90% of their taxable income to shareholders. While this makes them a fantastic income investment, these companies do not have the luxury of retained earnings. This means REITs must be extra disciplined with how they manage their funding and investments.
Since I would like to see Ladder Capital prove it can manage the rigors of being a REIT, I am not buying today. Instead, I will add Ladder to my Motley Fool CAPs account to keep a closer eye on what I think could be a very enticing high-yield investment in the near future.
Dave Koppenheffer has no position in any stocks mentioned, except in his (for fun) Motley Fool CAPs account -- which is beating the market, booyah. The Motley Fool owns shares of Bank of America and owns and recommends shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.