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ARBOR REALTY TRUST INC ABR S
June 16, 2023 - 10:27am EST by
cfavenger
2023 2024
Price: 14.25 EPS 0 0
Shares Out. (in M): 181 P/E 0 0
Market Cap (in $M): 2,579 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0
Borrow Cost: Available 0-15% cost

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Description

Executive Summary:

  • Arbor Realty Trust is a REIT which provides short-term bridge financing for buyers of transitional multifamily housing

  • Arbor fell into the trap of ballooning its balance sheet with assets at the cycle peak (2021-mid 2022) before spiking interest rates and declining rent growth impaired the value of these projects.

  • We see Arbor common equity seriously impaired to wiped out by marking their book to economic reality, although before that outcome is realized Arbor is likely to cut and then eliminate its dividend, severely disappointing the retail investors who have flocked to the REIT.

  • The short-term nature of Arbor’s assets in tandem with their own highly leveraged inflexible balance sheet should force a reconciliation in relatively short order

Thesis:

Arbor Realty Trust is a commercial real estate mortgage REIT focused on making bridge loans to the multifamily property sector. We believe it is facing the type of existential challenges one might expect when a levered lender in credit and rate sensitive assets nearly triples its balance sheet over a 21 month period characterized by generationally low interest rates and unbounded enthusiasm over the prospects for the type of residential real estate that most benefited from stimulus. The prospects of dividend cuts, massively dilutive capital raises, both or worse might sound like hyperbole, but as we lay out below, our concerns are driven directly from the fundamental challenges Arbor faces and the simple math implied.  

Bridge loans are short-term (2-3 years) loans at relatively high interest rates used to purchase and stabilize  properties before hopefully refinancing them with long-term takeout debt. Arbor saw massive asset growth through the pandemic period when interest rates hit rock bottom levels and housing inflation skyrocketed. See https://www.propmodo.com/loans-supporting-troubled-multifamily-deals-nearing-maturity-causing-concern/. At YE2019 Arbor had roughly $7B of assets which have grown to approximately $17B today. The vast majority of the loans Arbor currently holds loans which were originated  in the 2021-mid 2022 time period when the 10-year Treasury yield was between 0.50% and 1.5% versus 3.75% today. 

A rating agency pre-sale report from one of Arbor’s 2021 bridge loan securitizations illustrates the aggressive assumptions underlying Arbor’s lending practices. Loans were made at 83% LTVs with the assumption that rent increases and capital investment could drive those LTVs towards 70% where the loans could be refinanced by the GSEs.

While Arbor does not provide detailed visibility into its portfolio, Trepp data shows the mean Arbor-financed property was built around 1967 and would be designated “Class C” multifamily. This is consistent with industry contacts which view Arbor as the C-class originator of multi-family loans to syndicators and small LLCs, relative to Walker and Donlop (WD) which is considered an A-class originator to institutionally sponsored assets.

Arbor has two big problems. First, the rapid rise in rates post-pandemic puts upward pressure on the debt burden of these projects and downward pressure on their valuations. Second, rent growth in their key Sunbelt markets has stalled,which makes it unlikely many of these projects will reach anywhere near their stabilized projections. Each of these problems challenge Arbor’s business model of getting these loans refinanced, but in concert they compound the issues because the gating factor to GSE takeout financing is debt service coverage ratio (DSCR). Fannie and Freddie require 1.25x including principal amortization at minimum. Higher interest costs and lower than projected rents pressure both the numerator and denominator of this ratio. 

Let’s use an example to illustrate what this means. Assume that projects financed in the 2021/2022 time-frame were purchased at a 4.25% as-is cap rate. If the buyer paid $100 and borrowed at an 85% LTV there is $85 of bridge loan debt. The 4.25 cap rate implies the project throws off $4.25 in annual NOI. Current GSE multifamily rates run around a 200bps spread to the 10-year Treasury yield or approximately 5.75%. As mentioned, the most generous GSE financial programs require a 1.25x DSCR. Therefore, before even considering principal amortization, $4.25MM in NOI could support $59MM in debt at a 1.25x DSCR. But remember, Arbor extended $85 in bridge financing which is now $26 underwater or 30% of the loan’s principal balance.

But what about those rent increases and “stabilized” projections which would offset the rise in interest rates? Arbor finances its portfolio with a combination of CLO debt and repurchase facilities (repo) and for the half of its portfolio in CLOs we have relatively up to date transparency via Trepp into how things are going. We examined data through 1Q23 on 224 loans in Arbor CLOs with a total balance of $5.7B out of roughly $8B of Arbor CLO financed bridge loans. Those properties were generating $370MM in annual net cash flow. Again, using current GSE rates of 5.75% and a 1.25x minimum DSCR and again ignoring the fact that the GSE’s consider principal amortization when calculating DSCR,, $370MM would support maximum refinance proceeds of $4.1B which leaves a $1.5B hole for Arbor or 36% of the principal amount. 

While these numbers are large they align with troubling qualitative evidence out of the multifamily sector. Nitya Capital appears to be Arbor’s single largest CLO financed borrower (again we don’t have transparency into the half of assets financed internally on repo lines) with $400MM of identified loans across nine properties. In February, Nitya sent its investors a letter admitting that multifamily properties it purchased in 2021 lost 44% of their value when interest rates rose. 

 

SOURCE: Real Estate Alert

In a March 16 note, Barclays analyst Lea Overby commented that, “[Nitya] reportedly has $2bn of senior debt on its 60 properties. As short-term interest rates have risen, it is paying $60mn more annually in interest costs compared to what it paid in 2021. The article highlighted a Jacksonville portfolio which the firm bought in late 2021. While the rents on the portfolio have gone up by 22% under its ownership, the portfolio is cash-flow negative due to rising interest rate costs and the firm is covering the shortfall.”

Or consider the Houston Applesway portfolio which Arbor foreclosed on in the first quarter. According to The Real Deal, Arbor placed a credit bid on its own portfolio well below the principal amount due and won the bid as no other potential buyers emerged.These were 1970s-era Class C properties (which appears fairly representative of the overall Arbor portfolio). The property was ultimately sold for $196MM or a 13% discount to Arbor’s loan value. Did Arbor recognize the default and subsequent foreclosure as credit loss? No. Rather, Arbor  provided 100% LTV financing to a new buyer to make this sale happen as the properties were in a tragic state of disrepair and in need of  massive capital investment. In other words, the mid-teen percentage writeoff is probably understated as Arbor moved from what was allegedly an 85% LTV position to a 100% LTV position.

Rent growth is not coming to the rescue. Multifamily rents are no longer spiking as was seen in the 2021 period. Nationwide, effective asking rents on new apartment leases only increased by 0.3% as of April which is well below the rate of cost inflation for landlords (https://www.realtor.com/research/april-2023-rent/) and marked the 15th consecutive month of slowing rental growth. Even the sunbelt markets which saw the frothiest increases in housing prices are seeing weakness amidst demand destruction and near-record deliveries of new multifamily supply (https://www.costar.com/article/1372644014/sun-belt-no-longer-the-nations-multifamily-rent-growth-leader).  

In fact multifamily rent growth is now running negative in some of the hottest housing markets of 2021 (where Arbor originations were concentrated) such as Jacksonville and Austin. Supply continues to come online in size putting downward pressure on renst with multifamily units under construction still at an all time high (See https://www.globest.com/2023/06/13/apartments-compete-for-new-renters-amid-burgeoning-supply/):