KKR Real Estate: Stable Stock, High Yield, Static Price Performance (NYSE: KREF)


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KKR Real Estate Financing Trust Inc. (NYSE: KREF) is a United States-based mortgage real estate investment trust (REIT) that originates or acquires primarily commercial real estate (CRE) first mortgage loans. The Company’s investment objective is the preservation of capital and the generation of risk-adjusted returns primarily through dividends. The company was incorporated in New York on October 2, 2014 and paid regularly quarterly dividends since 2017.

KKR Real Estate Finance Trust Inc. has diversified its portfolio both geographically and by product type. Its major markets are spread across Texas, Massachusetts, California, New York, Florida, Pennsylvania, Virginia and Illinois. 46% of its assets are in the multi-family segment, while 28% are operational in the business office segment. However, almost all of the activity is focused on first mortgages. The Senior Loan portfolio represents 99.4% of its total business portfolio.

Portfolio overview

Portfolio overview (company website)

KKR Real Estate Finance Trust Inc. engages in the origination and purchase of CRE-related credit investments, including leveraged and unleveraged commercial mortgages and commercial mortgage-backed securities . Its first mortgage loans are based on transitional (secured) CRE properties, in the range of $50 million to $700 million. The duration is usually between two and three years, with some extension options. Interest on Senior Loans carries a premium of 3-4% over the Secured Overnight Funding Rate (SOFR). This interest is much lower than the more than 10% interest rate of mezzanine loans.

SOFR is to the US what LIBOR is to the UK. Large financial institutions, mainly banks, need to borrow overnight to generate cash and meet their reserve requirements. They borrow by negotiation (bid-ask) from each other using treasury bond repurchase agreements (REPOs), where they hold those treasury bonds as collateral. The SOFR comprises the weighted averages of the rates charged in these repo transactions. “Since 2019, billions of dollars of SOFR-linked floating-rate notes have been issued in the United States, according to Ajay Patel, Thomos S. Goho Chair in Finance at Wake Forest University’s School of Business.”

KKR Real Estate Finance Trust Inc.’s primary investment objective is to protect shareholders’ capital and produce attractive dividends for its investors. This company is not very committed to price growth. It pays regular quarterly dividends since 2017 on a very attractive yield. It generated annualized returns in the range of 7.84% to 9.6%. Over the past 5 years, the average annual return has been nearly 8%.

Despite the pandemic-related stock market crash in March 2020, the company kept the quarterly dividend payout unchanged at $0.43. Given that dividends are paid out of interest income, which again is almost certain to be repeated in future years, I expect KKR Real Estate Finance Trust Inc. to generate almost the same performance level. As nearly all of the bond portfolio is at floating interest rates, this mortgage REIT is also fairly hedged against interest rate risk.

Since its inception, KKR Real Estate Finance Trust Inc.’s share price has remained almost static between $20 and $22. It wasn’t until the pandemic-related stock market crash of March 2020 that the stock fell below $10 and took nearly a year to return to the old range. The REIT has recorded negative price growth of 8.64% over the past 30 quarters. Over the past three and five years, the price of KREF has decreased by 0.4% and 9% respectively.

Price performance has also not been impressive in the short term. KKR Real Estate Finance Trust Inc. has seen an 11% drop over the past six months. Additionally, the stock is likely to see further downward movement, as all long-term simple moving averages (SMAs) for this fund are placed above the short-term SMAs.

As of April 22, 2022, the 200-day SMA (21.2), the 100-day SMA (20.93) and the 50-day SMA (20.62) and the 10-day SMA (20.4) indicate a short-term bearish rally for this ETF. Only in the last 12 months has it been able to register positive growth, but that too is a marginal 2%. In a nutshell, KKR Real Estate Finance Trust Inc. is not for investors looking for growth.

KKR Real Estate Finance Trust Inc. has a very small market capitalization of $1.23 billion. Total debt is approximately $5.3 billion, or 80% of total equity. The price/cash flow of 10.8, however, looks a bit unappealing, compared to the sector median price/cash flow of 8.32. However, the price/book and price/sales of this REIT are quite low.

A price/book value of 1.05 and a price/sales of 6.26 suggest that investors are not optimistic that KKR Real Estate Finance Trust Inc. will use its assets to generate sufficient cash flow and of its sales to generate sufficient cash income in the future. In general, there could have been a possibility that these expected lower cash flows would have an impact on the distribution of dividends in the future. However, KKR does not have this option either, as it pays dividends on the interest of the senior notes, which are again protected from interest rate risk.

That said, I have to acknowledge that the overall historical total return cannot be considered discouraging, over the period in which it paid dividends. Over the past five years, its average price loss has been very minimal at 1.7% CAGR, while it has averaged a return of around 8%. A return of more than six percent over the long term is quite acceptable for investors looking for income.

Moreover, such investors do not need to sell these stocks in a hurry, as the price is quite static in the $20-$22 range. From a long-term perspective, I’d like to own this mortgage REIT and take advantage of the 8% plus dividend yield, and only liquidate the stock if there’s significant capital appreciation. It’s more like a good rental property where I can take advantage of rentals and wait for the opportune moment to sell it.

However, it will be wise to hedge my exposure by buying a longer duration put option, if available at a low premium. Since I expect the price of KREF to be between $20 and $22, buying a put option at $20 will protect my investments against an unexpected price loss. The October 21 put (6 months ahead) with a strike price of $20 was last traded at a premium of $1.15. I would prefer to buy the put near such a premium to minimize my loss, which will be less than 7% of the current market price.

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