Hi, welcome to Citi's 2024 Global Property CEO Conference. I'm Arren Cyganovich, with Citi Research. Pleased to have with us Claros Mortgage Trust and CEO Richard Mack. This session is for client Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those of you in the room or on the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions if you don't wanna raise your hand. So I will turn it over to you, Richard. The first question we always ask everyone is, you know, what are the top three reasons an investor should buy your stock today?
Okay, well, I may go over the top three to maybe include five, but I'll do the best answering the question. Look, we're trading at a big discount to book value. We're paying a dividend. So I think it's an opportunity for people to get paid to wait. But that's really what you could say about the sector generally. I think what differentiates us is, number one, we are real estate owner-operator developers. We've been through this before. We know how to manage our borrowers' problems, help work through those issues, and understand how to support our borrowers and when not to support our borrowers. We are low leverage. We have a low office concentration, and we provide what I believe is a high level of disclosure.
I think we sometimes are penalized or have been in the past for having a lot of construction loans, particularly in multifamily. Those are really performing well. I think one of the big reasons they're performing well is because we have strong borrowers. They're the best assets in their markets. Let's not forget, they generally have completion guarantees, which include interest coverage guarantees. So those are just some reasons that differentiate us, and I think make us different. Just a little bit, on kind of background, Claros Mortgage Trust is part of a larger company, called Mack Real Estate Group. We have about 250 people across the country, development offices on the West Coast, in the Southwest, and the Southeast, and are based in New York. We are an owner-operator, manager, and property manager and developer of assets.
So we have the skills that our borrowers do. I think that gives us the advantage to, the ability to understand their business plans in a differentiated way.
Thanks. Maybe you could start off with describing, you know, how's the lending environment today, and how does that compare versus, say, a year ago?
Yeah, so I wanna start by saying that as compared to 2 years ago, things are very, very different, right? Elevated base rates and elevated spreads. But as compared to last year, we are starting to see some differentiation. Spreads are actually coming in that you as you would expect, when rates have moved up so much. But really, it's the best projects. The best projects are starting to see a lot of bids for them and spreads coming in a bit. And the more difficult projects really are having a hard time getting capitalized. So we're starting to see differentiation. We're starting to see capital come in. We have a lot of inquiries to sell loans. We've sold loans, at par and close to par. And we're seeing new entrants come into the market, providing liquidity.
So we're starting to see some green shoots, even in the face of a rate environment that is tremendously uncertain.
The industry's seen negative credit migration over the, you know, past year. You haven't been immune to that. I, I think at the year-end, you had about 26% of the portfolio on what we would refer to as a watchlist, you know, rated four or five on your internal rating scale. You know, are there any, you know, themes that led to some of these challenges, and, and, you know, what reserve actions have you taken to help prepare for potential losses here?
Sure. So I think we are fast to move assets to higher-risk category. But that does not mean that they're not gonna pay off or and/or pay off in full. We just had, last week, I believe, a four-rated asset payoff in full. So we tend to move things as a result, certainly, of events that we can't forecast and we wanna be careful about. So an impending maturity where someone may not make the as-of-right extension may be a reason to move it to a four, but it doesn't mean that there's going to be a loss. So, kind of, we're really trying to look at this as a way to give transparency to our portfolio that doesn't always reflect that there's a problem.
One of the big things is that we have always had run with a high level of risk-rated loans. And if you look going back historically, it's been between 10%-25%, with some variability in there all along. And that's been because we've usually taken the view that, when there's some type of default, even if that default was a small default, that's going to create more leverage for us relative to the borrower. That's a reason enough to move the risk rating. And so I, you know, the risk ratings for us are important, but they don't tell the whole story. And looking at how our history has been with higher risk rating, I think tells maybe the better story about how we think about risk rating going forward.
Maybe just on the reserving, have you reserved for, you know, your risk-rated 5 loans? Do you have specific reserves against this?
Yeah, so we think that we're reserving for five-rated loans properly. And certainly, there are some four-rated loans that we've taken reserves on. But we moved some from three to four where we had already taken the reserves, and moving it from three to four didn't create a reason for us to increase our reserves on them. So we're trying to get ahead on taking reserves, whether it's related to where the loans are rated or not, and just thinking about what the probability-weighted outcomes are.
Maybe you could talk about, you know, some of the options that you have, you know, whenever you're looking at a loan and, you know, you're thinking about some sort of restructuring, if it does reach that default stage.
Yeah, so, we think that we're kind of really well-positioned that we kind of I think your question is kind of, you know, what to me, when we were talking about this, was, what's in our toolkit. And we kinda think we have basically every tool available in the toolkit, right? We start with the premise of if we have a borrower who is executing and putting capital into the into a subperforming asset, they're doing both of those, we're gonna work with them. Sometimes if they're doing one of them, we're going to work with them. But if they're doing neither, we're gonna take very drastic action. Thus far, we've taken back two assets. REO, I think both of those were the right things to do.
If you look at our hotel portfolio, which is the one that's a little bit mature on our books, cash flow is back up to above 2019 levels. And if we were in a normalized capital market, we'd probably have not only a profit above where we could have sold that loan when we took it back, but maybe even a profit above our par basis. But we're gonna be patient in thinking about when we sell it because it's cash flowing. It's got fixed-rate financing on it. And so we don't feel like there's a rush. The second asset that we took back, it's really too soon for me to kind of start talking about metrics, but we've seen a lot of low-hanging fruit in that asset. And again, both of those were situations where not only was the borrower not executing well, they weren't protecting with capital.
And so I think we really start with our framework. We don't want to extend and pretend. And that is gonna be thematically how we've operated and how we are going to try to operate going forward.
We've seen in the industry some, you know, credit issues popping up within multifamily. It's, I think, multifamily's about 41% of your portfolio. I personally feel like the fundamentals are pretty solid in multifamily generally. You know, what are your views on multifamily, in your portfolio and for future investments?
Yeah, so a lot of our multifamily are in the high-growth markets. So those are the markets that are struggling the most. We think that they're, and then there are also some of the gateway cities that have not recovered. So those are the places where there are problems. As it relates to the oversupply issue, new supply has kind of dropped off a cliff. And so it's gonna get absorbed, but it's gonna be a little bit painful with kind of negative rent growth in some of these high-growth markets for a while. But our overall view is that we're undersupplied in housing in this country. And so we are very constructive long-term on multifamily. But valuations are unquestionably down. However, I think what's kind of interesting is there are very few trades.
The trades that we are seeing are still generally happening with negative leverage. So, how much longer that is sustainable, I don't know. Kind of multifamily thing multifamily assets that are trading are trading relatively well. We haven't really seen a big push to liquidate yet. I, I we're constructive on multifamily long-term, but I think we have to note that there are headwinds at this moment in some of the gateway cities and in the high-growth markets.
I'd say last year, investment activity for the group has been, you know, relatively muted. Folks are dealing with problem assets, deleveraging. Most of the, you know, investments have been to prior commitments. You know, what do you need to see to make you more confident you'll be able to start to grow the portfolio?
Well, I think it's probably the whole market, but that is probably looking at it this way. But as it relates to us specifically, we are kind of on hold trying to understand where and when market stability is going to happen. And market stability is really gonna be driven around clarity as to where the forward yield curve is going to sit and where short-term rates are going. Until there's kind of clarity around that, meaning either that we are gonna be at 5% for three more years and kind of we're in a world of distress and kind of you gotta rethink everything in your portfolio, or we see real clear indicators that there are gonna be rate cuts, I think we need to wait to see that stability.
That stability, in turn, I think will be an indication to a lot of capital still on the sideline that now is the time to buy because discounts may retreat as the world comes back. And so that we're waiting for that indication to start thinking about things other than managing our liquidity. And so right now, we're thinking about liquidity, and we're not focused on growth and opportunity. But long-term, I think that once there is stability, alternative lenders are going to play a much bigger role in the market than they ever have before. The movement away from regional banks and the regional banks lending in real estate and the money center banks in having an increased cost of capital is gonna make non-bank lenders a more central part of this market than ever.
And so if you can look forward to the point of stability, it actually gets a little bit exciting.
Maybe it was on your last earnings call. You, I think, you talked about, you might see some slow rebuilding of confidence in the real estate market, and it may take until 2025 to see, you know, fully embrace refinancings and recapitalizations. You know, can you expand on your thoughts there? Why do you, why do you think it'll take a bit longer?
Yeah, I mean, it really follows on my previous comment. We need more confidence in the market for transaction volumes to happen because the market is kind of locked up. And, you know, there have been commentary from distressed investors that if you wait for there to be clarity around rates, it's gonna be too late. As a lender, we do not need to be first to this dance, but we're gonna need to see people stepping in, and there'll be confidence in the market for transaction volume to pick up. And kind of until that happens, it's just hard to see any reason for people to transact. And, you know, right now, a lot of what the market is doing is saying, "We wanna pay for option value until we have more clarity." And so we see that happening everywhere in the market.
Everyone's doing it. That's the game. We try to make sure that our borrowers are paying as much as they possibly can for that extension option, and we're not granting it for free.
You know, maybe you could talk a little bit about, you know, what, what kind of property types would you favor financing today, and, and are there any that you're, you know, specifically avoiding?
Yeah, so we've tried to think about that every day. We were purposeful in having a very small office concentration. I don't think that we understood the full extent of the difficulty that office would have. But our perspective was that you've gotta be really careful with any asset class that trades on NOI and not cash flow. And so we've just had a negative bias to office. We had a negative bias to retail. We have zero standalone retail. We're more constructive on that today than we have been in the past. And if you think that we're headed towards a recession, you certainly have to be really careful about hospitality. But when I think when we look at our, our portfolio concentration and construction, I think we're pretty comfortable with it. We might be opportunistic around office, but it's gonna be always gonna be our smallest asset class.
I do think we wanna try and do some standalone retail in the future because we believe that that market has stabilized. The reason we didn't lend on retail historically was and the reason we don't have very much office is because on the bad retail, you can't get paid enough to lend on it. And on the good retail, you couldn't get paid enough to lend on it, right? So in fact, the bad retail, there was no price they could pay you to lend on it because of the absolute binary outcome surrounding a lot of retail. So I think we're kind of allocated properly, but we'll be opportunistic as new information arises on each asset class. And this is a market where every geographic location is different as to how different subsets of asset classes is performing.
Every market is different as to how they account their economies are performing. And so, it's really about the micro in each market in which you operate with kind of an allocation perspective at the portfolio level, thinking about the macro.
That was gonna be the next part of the question was, you know, are there any geographies that you see within the U.S. that are more attractive? But I guess you're basically saying it kind of depends on property in those geographies.
I think that's right. There are a few themes that are really interesting right now as real estate investors. You know, one of those is the impact of onshoring and nearshoring. I think people are underestimating the impact that's going to have in terms of job creation and net population migration in the U.S. We're starting to track that on the equity side of our business. We think thematically, being able to lend in that area will be interesting over time. Generally, it's just market and asset class specific.
Maybe you could talk about what kind of new loan spreads you're seeing in the market today. You know, what were they pre-pandemic, and, you know, how does that compare to what you have in the portfolio?
Yeah, so, spreads kind of pre-pandemic, or call it, 350-450 over, those moved, since rates backed up, probably 100 basis points. And if and for the best assets have probably come back in about 50 basis points, you know, reflecting on the fact that good assets, there's seems to be competition for, and bad assets are really having a hard time finding anyone to lend on them.
The industry's earnings, I guess, are benefiting from the higher base rates that we have right now. You know, how are you positioned whenever rates start to come down and the Fed pivots, so you start to see some of your, your base rates fall?
Yeah, I think, you know, it's one of these situations where, as the real estate market generally feels, like, good news can be bad news, right? So, as base rates come down, the value of our book and, I think, the discount to book value should decrease. But also, more loans will get paid off and come off non-accrual. So the impact to earnings is modest, but it does exist. But the value creation in book value and the benefit of getting loans off of non-accrual will more than offset any reduction in base rate that you're getting. Plus, I should add, we generally have floors in these loans. Of course, we've blown way through these floors. And so those floors do give a level of stability. And so, you know, getting back when rates were super low, movement up was very valuable.
Now, we wanna try if we could get to a more normalized rate environment, not a super low and not a super high one, mid-three type of rate, that has a really positive impact while keeping earnings pretty high on the overall book value. And so if you think that that's where rates are going, that's a pretty constructive place for floating rate gen lenders generally and for the industry.
Got it. Maybe from a funding perspective, we're seeing, you know, issuance improve and corporate debt and CMBS markets. What, where are the most attractive forms of funding that you see today, and how would you be funding new originations?
Yeah, so in the beginning of January, it looked like the real estate capital markets were gonna really rally, and CMBS was gonna lead the way, and CLO market would come back other than multifamily, which we've seen some issuance, kind of all on the heels of that. And then we got some bad news and that, like, fell away. So my short answer is there's no great place to finance things today. However, what I do find interesting is that if you're willing to pay a little bit more, people will give you a big advance rate or pay what you were paying before, I should say. People will give you a big advance rate. And we have, because we are low-levered, we have people saying, you know, "Can we provide you financing on your unlevered assets?
Can we give you more leverage?" which is both encouraging and strange to me in this environment. But I think what it's reflecting is that there's starting because transaction volume has been low, you're starting to see people say, you know, "I've raised this capital. I gotta put it to work." So nothing is super attractive, but capital is available. I guess my view is if you're originating today, the best thing to do is originate unlevered and wait for the capital markets to come in a little bit before you put leverage on it because I think that you'll like the pricing better. And given how much risk there still is in the world, you might want like to have unleveraged assets for a little while.
So I think you wanna be patient about financing them in an environment where I think there's a lot of chaotic capital market instability out there.
In terms of, you know, leverage expectations, would you expect to kinda continue to delever the portfolio, or would you?
I agree, until you have a real indication that there's capital market recovery, I think that it's prudent to delever. And with base rates where they are, I don't think you're getting paid that well to leverage them. It's just because when you look at the relative accretion of leverage today because base rates are such a bigger part of the return, you're not picking up as much on a relative spread basis. So in today's environment, there's a lot of reasons not to use as much leverage. And I think, you know, being low-leverage has provided us with a lot of flexibility such that if we really were confident, we could expand our balance sheet and lean in. I think, you know, at this point in time, we don't have conviction, and so we're trying to be prudent.
Okay. We do have a couple investor questions. One was on a negative credit rating outlook. Are there any concerns on that aspect?
We're concerned about everything all the time, every day, right? So, like, we come into work, and we say, "Who's paying us off now?" and, you know, "Where's our where's our next liquidity event coming from?" We handicap them. Things don't happen on a quarterly basis the way you'd like to have them neatly in your, your in your earning sector. And so our expectation is that, you know, if we continue to do our job, we resolve loans, we increase liquidity, the world comes back. Maybe we can change that, that, that, that rating. But our job is to go to work every day and try to work through problems and get paid off and get ready to go on offense again. And that's kind of and make sure that we have enough cash to keep, keep everything going.
So, we're trying, you know, we try not to worry too much about the ratings, although, you know, if you're asking me what I'm worried about, it's everything every day.
Yeah. The second question's kinda related. How do you think about liquidity over the next few quarters?
Yeah, I mean, we think about liquidity every day, right? We like having unlevered assets. We know where and how we can lever those if we needed to. We think that people keep approaching us to sell loans when we get the prices that we like. We're, you know, we're a seller. I think we've been pretty successful at selling at or near par. And so we're just constantly saying, "How do we manage earnings against liquidity every day?" And it, you know, that is kind of the environment that we're in.
You know, whereas there was a time when we were, you know, "How do we manage having enough origination so that we're keeping earnings going?" And so, you know, this is a business where managing your cash is dynamic in an environment where you're originating and an environment where people aren't paying you off as fast as you wanted to. So this is the same dynamic that we were managing previously when we were trying to put out cash rapidly in reverse. And so we're used to having to manage our cash. Therefore, this is art, not science.
The industry, I guess, over the past several years have increased the amount of non-mark-to-market funding. It's been a kind of a focus for commercial mortgage REITs. What's your proportion of funding that's non-mark-to-market? And what's the risk that, you know, credit marks for struggling properties would, you know, cause a margin call?
So, yeah. So, there's a lot of ways to look at this. The first thing to note is that, even when you have mark-to-market, these don't work like repo loans where, you know, they take your collateral, see you later. And we've never had a margin call. But more than 50% is subject to margin call, though we've never had one. And we have fairly wide bands at which margins have to move before things can get called. So it's definitely a place that we think about and worry about. But we think we know how to manage our relationships there. And we haven't had, you know, given everything we've been through, we haven't had a negative result yet. But it is something to be worried about or concerned about, I should say.
I forgot to ask this earlier, but what are you seeing from a competitive environment? You know, banks have generally, you know, kinda pulled back from the market?
Yeah, so it's a have-and-have-not market. You know, our counterparties seem to wanna extend us more credit, which is great. We're reluctant to take it. But I think the bigger people with more infrastructure who can demonstrate through different cycles that they can handle problems are gonna continue to have access to capital. And other people who haven't necessarily been able to do that are gonna struggle.
All right. We're wrapping up here. What's one area that you think investors are underappreciating about your company or strategy, that you'd like to highlight?
Yeah, I mean, I think, you know, these 1 and these 3s are hard for me. So I think I'll just reiterate what I said at the front end, you know. Low leverage, low office, high degree of disclosure. But if I have to pick one thing, it's that we're real estate people. We've been through this. It's not fun. But you work through it. You get to the other side, and you solve problems. And you don't ignore them. And I think that is, when you're used to owning assets and you're not afraid to own assets, I think it gives you an advantage to not trying to extend and pretend and really dealing with issues.
All right. Well, thank you, Richard, for coming. We really appreciate having you.
Thank you. Thanks for the questions.