Welcome to the 9:55 session of Citi's 2023 Global Property CEO Conference. I'm Nick Joseph with Citi Research, and we're pleased to have with us Claros Mortgage Trust CEO, Richard Mack. This session is for 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 in the room or on the webcast, you can log into LiveQA.com and enter code GPC23 to submit any questions if you don't wanna raise your hand. Richard, we'll turn it over to you, and you can introduce yourself and your company, and provide any opening remarks before we go into Q&A.
Okay. Hi, I'm Richard Mack, CEO of Claros Mortgage Trust. Claros Mortgage Trust is an externally advised mortgage REIT. It's advised by Mack Real Estate Group. Mack Real Estate Group is a owner/operator, developer, and property manager with assets across the country. Claros distinguishes itself as an investor by looking to take execution risks that we think we are uniquely positioned to evaluate and take on. We think that allows us to get paid incremental return while using less leverage than most other mortgage REITs. I'm very happy to be here. Hopefully, that's a brief synopsis of who we are.
That's great. Thank you. We'll start off with same question we ask everybody. What are the top three reasons an investor should buy your stock today?
Price, price, and price. Oh, so, yeah. I mean, I've said a little bit of this in my opening remarks. We're gonna go through a difficult period of time. We think being low levered is going to really allow us to have a lot of flexibility to work through problems. Everyone's gonna have problems. Additionally, we think that having very low office exposure is really key here. The office exposure that we do have is what we would call non-commodity. That is by design. We think non-commodity after Class AAA is really gonna be what outperforms and what people want going through the next few years. We have no Europe.
Unclear how deep a recession Europe is going to have, or whether or not Europe is gonna deal with any of its problems. You know, maybe there's not much of a dip in Europe, but I think Europe could have some complexity. You know, we've got this unique model that will allow us to kind of work through problems. Our borrowers understand that we have the capacity to take back assets. It's not what we wanna do. That generally brings them to the table to put up more capital and to work a little bit more aggressively as opposed to thinking that we're not prepared to take strong action.
I think those are the main themes that are gonna position us well outside of price and allow us to accrete book value up over time for our investors.
Thanks. The other question we have that we are asking every management is what is your number one ESG priority in 2023?
That's definitely the question that you showed me, but I'll do my best at answering it. I don't think that we have a number one priority, but we are really doing our best to think about ESG in everything we do. When we are making a loan, we're evaluating, you know, what are the environmental problems that could come up where this property is located, and what is the environment going to do to the economy in that overall market. I think as a lender, you have to be looking at the environment at all times. I think governance is part of everything that we do, and we have a diverse board, and we believe in transparency in everything that we do.
I think governance is not new, but it's important to just to be focused on it. Social is a big part of our business. Kind of, we think about, we are involved with Project Destined, for example, trying to bring in more minority candidates into the real estate business. Mack Real Estate Group has a big commitment to volunteerism and to matching donations. I can go on and on about this. Let's maybe just keep going, and hopefully that was a strong enough answer.
Thanks. We'll move on to, you touched on this a little bit, but, you know, how would you describe the current CRE lending environment today, and how has that evolved kind of pre-pandemic and post-pandemic?
Look, unlevered returns are at probably the best on a risk-adjusted basis that I've kind of ever seen. I think it's a really interesting time to put out capital. You can get close to 10% unlevered returns, and it's extremely interesting in the transitional lending space. But at the same point in time, higher interest rates, which are great for our business, make it more difficult for some of our borrowers to pay. What you've got to presume as an equity investor and how we look at the equity, the business from the equity side of Mack Real Estate Group, is that you've got to be able to look through to a world where rates are gonna, where rents are gonna catch up to rates, and where rates normalize.
In that environment, asset values coming through an inflationary period should be much stronger. It's a very complicated market to navigate because interest rates have moved so quickly and have moved, as a general statement, faster than rates. And the last thing is, banks are far less aggressive and are really, really discerning about who they'll provide capital to. And as a mortgage REIT, you need participation from the banks in your business, and that's getting harder for a lot of mortgage REITs, fortunately not us, to get access to. It's a pretty interesting time to see rates move so quickly.
What are some of the asset property types that you currently favor, and maybe some of the ones that you might be avoiding, currently?
Very boring answer, I'm sure, and what we've been doing for a long time now is, our biggest sector is multifamily. We continue to have a focus on that. We like to lend on industrial, although until recently, it's been quite hard to do so because there's been so much competition for even transitional industrial lending. Hotel has really been a standout for us. We've increased our exposure to hotel during COVID and post-COVID, and really making a little bit of a bet that not only would asset values hold up, but that cash flow would come back as people decided to travel more. That's been the case. We're gonna continue to focus on those three areas.
That's really allowed us to diversify geographically, which was not the question, though, into some of the higher growth markets where those asset classes, where there's more borrower demand for capital.
That was my next question.
Sorry.
The geographic exposures, but that's fine.
Yeah. On geographic exposure, we've had a view that as a transitional lender, you wanna be where the growth is. That's where the developers need capital. It was a natural thing for us to diversify out of the larger markets. I don't think that trend of high growth in the Sun Belt areas is going away, and so we're gonna be continued to focus there. I think what's interesting is that our equity business has been focused there, in those markets pre-COVID, and being able to kind of follow the trends of our equity business for the debt business has been helpful.
Loan spreads are wider today. Where are you seeing them, you know, I guess, relative to pre-pandemic and also relative to where your portfolio stands today?
Yeah. I would say that lending spreads are probably 100- 150 basis points wider, but the base rate has moved 500 points or 450 points. That's really why the unlevered returns are so strong. Our ROEs are pretty consistent. They're a little bit higher than kind of before COVID. Maybe they're up from 13%- 5% or 16%. We're not stretching to take risks to make 20% returns here. We'd rather put out a little less money and keep our ROEs pretty consistent. That's kind of the approach that we're taking.
The non-traded REIT sector really had a big boom over the past couple of years. We're seeing, you know, some retrenchment there. Is that impacting your business, in any notable way?
It's not yet, but it may have an impact. I think it's important to quantify that the non-traded REIT sector is about $1.5 trillion out of about $21 trillion overall commercial real estate market. When you look at that, if they were to sell everything, I think there would be a big push down in values. On the way up, because it's a new sector, it definitely pushed asset values up. I think there would have to be a major sell-off in the non-traded REIT to have a big impact in the market. I do think some selling from the non-traded REITs will end up in borrowers' hands that have a value-add business plan, and hopefully that creates lending opportunities for us.
Certainly, you know, valuations are down and there are redemptions and non-traded REITs will sell, but I just don't think it's gonna have a huge impact on the market 'cause I don't see them liquidating on a wholesale basis and bringing down the gate certainly is evidence of that.
The, the commercial mortgage REITs as a whole are benefiting from the rising rates that you had talked about. Maybe you could talk a little bit about, you know, how you've benefited from that from an earnings perspective, and then, you know, what actions could you potentially take to limit some of the impact whenever rates start to go back down, which doesn't seem very likely anytime soon currently.
Yeah. Look, I mentioned this a little bit earlier. Higher rates are great for earnings until borrowers can't pay you. It's really a double-edged sword. I think what the best thing that could happen for mortgage REITs is for everyone to see a path for when rates are gonna come down, and then we could, you know, really feel good about the benefit that higher rates are having to our earnings because you could see that there was a ceiling, so to speak, to cap rates. I think we have to be excited about our earnings increases based on higher rates, but we have to hold liquidity to be concerned about where values are going and borrower behavior.
It's kind of giving with one hand and taking away with the other because you have to be ready for things to get more difficult.
That actually feeds well into we got an investor question online. Where, if anywhere, are you seeing early credit distress? Are we past the early stages in that?
you know, I think, of course, we're seeing it in office, but everything is pretty quiet. I'm very concerned that office is gonna become a very big problem in the capital markets, and that that could create larger contagion, if you will, that may create difficulties for the entire real estate capital market. We also have a lot of liquidity on the sidelines, kind of what's interesting is that when non office notes that are kind of non-performing or slightly non-performing go up for sale, there's a lot of interest in it. There's just a lot of capital looking to come in and take advantage of what may or may not be distressed, and it's happening faster than I would have thought.
I would have thought people would have waited longer to see where the bottom is. It's a pretty interesting dynamic. Not a lot of distress is being raised. People are finding capital to carry their assets if they can see through towards an inflationary environment where assets are worth more. Certainly, an office market, where banks are selling loans at big discounts or needing to take capital reserves, large capital reserves could infect the entire market, and we could see a much bigger debt downturn than maybe we're all expecting at this moment.
Your CRE loan portfolio closed the end of last year at $7.4 billion. I think it grew about $1 billion from the prior year. What are you thinking about in terms of potential for loan growth and originations this year?
I think it's really a question of how much liquidity we need to maintain, and we're trying to be really careful about that, and how many repayments we get. We're handicapping little to no repayments, but we expect that it's, you know, that it's gonna be better than that, right? That, you know, it's not gonna be as much as we'd like, but that, you know, given our average loan size of over $100 million, we generally have very well-heeled borrowers, and they'll find a way to refinance us, and that ought to give us a good amount of dry powder to do new lending at, you know, quite accretive rates.
But we're trying to be really careful and prudent about how we think about liquidity, and we're gonna try to use the capital that's coming from repayments as the source of new lending. Oh, by the way, spreads haven't moved that much, and so the base rates really helped us. Holding onto the loans that we have is really not a bad situation either. I think it's really gonna depend on repayments and what the market gives us.
Okay. You have a bit higher unfunded commitments versus some of the peers that we follow. Maybe you can just talk about what that is. Is it heavier transition? Is it construction? What, what are the aspects that are?
It's primarily construction loans. You know, if you've got a big enough balance sheet, we think construction is a really interesting place to play if you've also got the expertise. I so think we have both of those, and we try to balance it out. What we don't like about construction is money doesn't go out the door day one. You've got to manage your liquidity around the construction opportunities that you do do.
When you do construction on these larger projects, and you have the capacity to not only underwrite the developer's plans, but the general contractor, the subcontractor, the architects and the engineers, and to step in if there's a problem, and you've got a really strong balance sheet as your completion guarantor, what that means is that you're gonna get the best building in the market. We kinda like the risk dynamics around having the best buildings in markets with very strong sponsors. Those buildings are gonna outperform. That's kind of what we like about construction. We have not had to take over a construction project midstream yet, but we're prepared to do so if we needed to. But these completion guarantees and these completion guarantors are pretty darn strong.
we like our exposure, and we like that alpha that it gives to our portfolio. I think we've made one office construction loan, and everything else has been multi or industrial. I think we, you know, we feel pretty good about our construction portfolio.
How is the, you know, competitive dynamics there? I'd imagine that construction lending is probably.
Yeah, it's better, right? There's less people that wanna do it. That's kind of why we, you know, we generate pretty high returns doing it. It's a, it's a nice source of alpha for us.
In terms of the, you know, the optimal size for you to manage in terms of your overall lending portfolio, is there a size you expect to get to over time? Do you feel like this is a good place where you are now?
Well, I think our first obligation is to manage our existing business to get our shares up above book value. I think if we can do that, we can think about growth. We wanna be lower levered than our peers. That's gonna limit how much we want to expand our balance sheet. Query if now is a good time to expand one's balance sheet. Yes, it's pretty interesting to put capital out, but I think you need to be conservative and careful around what could happen in the capital markets. I think we just are gonna focus on shareholder value. If we do our job around shareholder value, and we've got some creative ideas that hopefully will continue to create value, that will allow us to expand.
I think, you know, we're at a sufficient scale, but I think more scale could be beneficial to the platform over time.
Got it. You had touched on office a bit, already. You know, obviously that's a big focus for investors these days. Maybe you just talk a little bit about some of the office exposure you have there and how well reserved you are for potential losses down the road?
Yeah. I mean, as a general statement, you know, our office is non-commodity. We think that will help us if we need to take assets back. Our goal is not to take the assets back and work with our borrowers. You know, the office dynamic is such that, you know, things are gonna get worse before they get better. There are certainly trends in Europe and Asia that people are coming back to the office, but in the U.S., they're just not. We're just gonna be really careful around it, and we'll be flexible with our borrowers. You know, office assets are actually, as a general statement, you know, can be easier to manage than anything else. Multifamily is much more difficult.
It's important to state we've owned a lot of office in our careers, in terms of the staff at Mack Real Estate Group, we made a conscious decision because we'd owned so much office in our past careers to have zero office on the equity side of our business and to have a very limited amount of office, in our, in our loan portfolio. That wasn't because we saw work from home coming. It was because we don't like the cash flow dynamics around office. We didn't like it before, and we don't like it now. We've had a, you know, just a very cautious view of office, and that's not gonna change.
What are I guess you just said it was not gonna change, but what are some of the things that you would like to see in office before you would have stepped back in into the asset class?
I think that you have to get... If you wanna step back into the asset class, you have to have a really unique asset or something that you think can be turned into a unique asset, and you have to get paid proportionate for the risk. I think I don't see us doing this, I think you have to really think at about 50% of cost at SOFR plus 600 or so, which is maybe where office loans are going to, if that's something you're willing to do. I do think there would, there could be instances where we might look at something like that, we're gonna have to be really cautious to do that.
I don't think that the market's going to reward us for putting on any office exposure, even at those types of lending spreads . I think that's probably what it takes to do it.
Got it. We have seen some headlines recently, of some stress in multifamily in various places. The rents are starting to come back down a little bit, and there's some concern about new supply. Why do you feel like multifamily should hold up better than folks think?
To the extent we're seeing distress, it's because we're seeing people who are not well capitalized or over-levered. As a general statement, the markets are quite strong. What you are continuing to see, which is burning off, is the mark to market in the rent rolls. That's gonna burn off, and you'll see NOI growth flatten, I think, pretty substantially, because it's unsustainable to have 10%+ rent growth per year. We have, you know, in a lot of markets, a good amount of new supply. I think that the fundamentals are pretty good. You know, you can't sustain the type of fundamentals that we've had, in multi. A flat lining of rents for a little bit is a normal course event.
If we have a recession, we could see some weaker fundamentals. On the other side, if you look long term, what you've seen is that multifamily starts have dropped precipitously. It's very expensive to borrow to build multi. I think long term, that will be and inflation is increasing the cost to build multi. I think long term, multifamily is, has very good prospects. I think midterm, like every other asset class, there's gonna be some distress around capital stacks.
Okay. The, you talked a little bit about, some of the actions you could potentially take, you know, in a restructuring or in a default situation. Maybe you can, you know, discuss how you're handling, any kind of stress within the portfolio or how you expect to handle that.
Sure. You've gotta treat each situation as a unique exercise. As a general statement, our borrowers are putting in more capital when they need to or buying a new cap if they need to, which is expensive because our caps were written, you know, well inside where SOFR is today. As a general statement, our borrowers are doing what they're supposed to do. Every, you know, borrowers will call you up and ask for relief and try to get you to help them even if they're well in the money.
You know, it and then there are some borrowers who may, you may think that they're more out of the money, who don't bother and just kind of get on with it and do what they're supposed to do based on the loan documents. You know, we're gonna have, it's gonna be hand-to-hand combat for everybody. We're gonna be, you know, everyone's gonna be talking to their borrowers. We believe in proactive asset management, which is, I think, another differentiator for ours. We wanna be ahead of the borrower. We wanna, you know, if we think there's gonna be a problem, we're gonna pick up the phone and call them first before they call us. This is gonna be, you know, every transaction is gonna have some type of a negotiation.
You really, you wanna work with your borrower to give them the best possible outcome while protecting the interests of shareholders. If that means that you have to say, "Look, we cannot give you more accommodation than this, and if you want, we'll take the keys," of course, we're willing to do that. You have to be willing to say that so that you can be as flexible with your borrowers as possible and as we wanna be. We're, we're all about providing flexible solutions to our borrowers. That's why they came to us in the first place, and we're not gonna change now.
It seems to me that there's more, you know, challenges from just the liquidity of probably office specifically than the actual fundamentals deteriorating. Most of the challenges or issues we've seen are from loans that are coming due near term. How do you feel about doing extensions for those borrowers, given that right now, just the environment for liquidity is just so poor?
Yeah. Look, extensions are definitely part of our toolbox. You know, most of the time to do an extension, we're gonna look for the borrower to put some capital in, to really show us they're committed. Look, they're under the right circumstance, we might do an extension without it. I mean, we're gonna be flexible, and we're gonna evaluate every circumstance. We also have borrowers that have as right extensions. You know, every loan is bespoke. I would say very, very few don't have some type of a coverage requirement, or debt yield requirement that they may or may not be meeting. You know, that gives us a lot of power.
At the same point in time, given the lack of liquidity in the market, we do wanna be flexible where we can be. We can't be too flexible because we want the cash because it's a great time to put it out. It's a real balance, on, you know, whether you grant extensions and what you require to grant them.
Okay. We'll switch gears to the right side of the balance sheet. Funding costs are rising along with the loan yields. What are some of the more attractive forms of funding that you're finding today to fund your new loan originations?
I think there are a lot of opportunities in the market. We are tending to stick with our knitting, so to speak, which is, we're a floating rate lender, we're a floating rate borrower. We borrow a lot less on our A notes and warehouse lines than we could. We try to give ourselves some cushion. While, you know, it may be imperfect, we do like and have great relationships with our bank warehouse lenders. We're gonna continue to use them. We're gonna continue to use A notes. We're gonna evaluate the capital markets. If we see an opportunity in the capital markets to issue longer-term unsecured debt, we'll certainly do so.
Again, I, you know, we're not anxious to balloon the balance sheet at a time when capital is costly. I think we'll wait and see if capital costs come in to the point where we wanna do something more than kind of just sticking to our business as usual.
Got it. Maybe just in terms of the leverage, are you seeing banks get a little bit tighter in terms of what they will advance on loans these days? What kind of leverage do you expect to be able to generate going forward?
Well, look, it's a real question of where V is. You know, C is down, but where is V? I think it's very, very hard to answer that question. We're lending less, and so, you know, the banks as a percentage of advance are pretty much at the same spot, but their attachment to attachment point is lower. That's kind of the way we're kind of perceiving our credit counterparties.
Non-mark-to-market funding has been an increasing focus among commercial mortgage REITs after the freezing of the markets in the pandemic. What proportion of your funding is non-mark-to-market?
I'd say about 80% is non-mark-to-market. However, you know, if you have an underlying default, you know, then there are mark-to-market consequences. It's a question of, you know, whether or not you consider an underlying default to be a mark-to-market, which we don't, but, you know, some people might.
Yeah, I think that's essentially how most people view it. Not that you have non-mark-to-market on a capital spread widening, et cetera, but if you have a credit issue. Have you had banks push you in terms of any specific product?
We haven't had any margin calls and, you know, part of that is because I think we're trying to be proactive. If we see a problem, we'll go to the bank and say, "Hey, we're gonna pay you down," or, "We wanna move this out of one facility and put it into another." I think we're gonna continue to be proactive, and I think that's why the banks wanna continue to do business with us.
Great. All right. Well, we'll close out on this one. What's one area that you think investors are underappreciating your story and your strategy that you'd like to highlight?
Yeah, I would kind of go back to where we started, which is lower leverage and small office exposure and the ability in a difficult market, because of those two factors and our execution capability of the broader platform, to, I think to outperform. That's, I think, the key as we wake up every day, that's what we're thinking about. How do we take advantage of the place that we're in right now and really use our execution capabilities to make sure that we get the best outcomes for our investors.
Great. All right, we'll stop there. Thank you very much for attending our conference. Appreciate it.
Thank you.