Description

     ACRE is a commercial real estate REIT. It is an fee generating investment vehicle sponsored Ares Management Corp (ARES). ARES is a successful and well regarded manager which offers a variety of investment vehicles. Over all their strategies, at year end 2023 Ares managed $419 billion of which credit was $285 billion and real estate was $50 billion. In real estate, Ares operates out of 17 offices/market coverage locations and employs 255 professionals who oversee 516 real estate investments. ACRE is Ares public real estate vehicle. Over the last 12, 24 and 36 months, it is the worst performing commercial mortgage REIT when compared to its competitors ARI (Apollo), BRSP (BrightSpire), BXMT (Blackstone), KREF (KKR) and TRTX (TPG). I believe that the management of ACRE is working hard to correct their mistakes and that the management of Ares is interested in their progress.

     At year end 2023, ACRE had a $2.2 billion portfolio of 47 loans. $570 million was in multifamily (26.5%), $240 million in industrial (11%), $166 million in residential/condo (7.7%), $113 million in mixed-use (5.3%), $98 million in hotels (4.5%), $78 million in self storage (3.5%), $53 million in student housing (2.5%), and $843 million in office loans (39%). As we are all aware, the rise in interest rates, overbuilding in some areas, and work-from-home has caused a decline in the value of real estate. The value of ACRE's office loan portfolio has declined. Some borrowers have decided to take advantage of the non-recourse nature of their loans and walked. At year end, ACRE increased its CECL reserve to $163 million or 8% of its total portfolio. Of this reserve, $149 million related to 10 loans that were rated 4 or 5 - somewhat troubling or deeply troubled. The troubled loans had a balance of $539 million, and the CECL reserve amounts to 28% of the loans balances. The better performing loans have an outstanding balance of $1.6 billion. In 2023 these borrowers contributed more than $150 million to purchase new interest rate caps or add to reserves.

     Against the $2.2 billion of loans, ACRE has borrowings of about $1.6 billion - secured repurchase loans (repos) of $640 million, notes payable $105 million due in 2025 with extensions to 2027, a secured loan of $150 million due in 2026, and a $725 million CLO. The repo lenders are risk adverse and can pull their lines at any time. The management of ACRE keeps them up to date on their assets and their problems with those assets. This is to the benefit of shareholders as an honest relationship with these lenders keeps ACRE's reporting robust.

     In the 4th quarter of 2023 generated $0.20 of cash flow available for distribution. ACRE reduced its dividend from $0.33 to $0.25 which is $0.05 greater than cash flow. Management explained that the $539 million of defaulted assets, $149 million of their CECL reserves, should generate $0.12 a share of earnings a quarter when the assets are sold/reworked. The troubled assets are mainly office properties. The worst is in Chicago and has a cost of $57 million against which a $40 million reserve has been taken. An office in California has a book of $33 million with a reserve against it of $15 million. It is my expectation that ACRE's problem loans will be dealt with quickly. It is also my expectation that the entire CECL reserve of $163 million will be used to clear their current problem loans and future problems.

     With the entire CECL reserve used, book value per share will be $11.56. With the stock at $6.75 a share, the market is applying a further discount of $4.81 a share or $260 million to the performing loan portfolio - 16%. At $6.75, ACRE trades at a 42% discount to book. I believe that this is a large discount and that, when the dust settles over the next 6 months, ACRE share will drift towards the $11.56 per share book. In the meantime, I will clip a $1.00 a year dividend, a 14.8% yield.

Catalyst

Resolution of problem loans.