Thank you guys for joining today. My name is, Matthew Erdner, Vice President of Specialty Finance and Real Estate Research for JonesTrading. I'm very pleased to be introducing Seven Hills Realty Trust, ticker SEVN, at the NAREIT conference. Seven Hills, formerly known as RMR Mortgage Trust, Maryland REIT. They originate and invest in first mortgage loans secured by middle market and transitional commercial real estate. The company is managed by an investment advisor, Tremont Realty Capital LLC. Tremont is owned by the RMR Group, and the RMR Group is an alternative asset management company that was founded in 1986 to invest in real estate and manages approximately $32 billion in assets. I'm excited to introduce the president of Seven, Tom Lorenzini, and Chief Financial Officer, Fernando Diaz. Tom has been president since Seven's inception in 2021.
In addition, he's also a Senior Vice President of Tremont Realty Capital, and a Senior Vice President of the RMR Group. With over 25 years in the real estate industry, he is considered one of the leading financing experts in the manufactured housing community and self-storage industries. Fernando has been Chief Financial Officer and Treasurer of Seven since 2023, and he's been with RMR since 2007. In addition to CFO, he is Treasurer and Vice President of Tremont Realty Capital, and a Vice President of RMR, responsible for credit risk and business analytics. He has over 15 years of experience as a securities analyst and portfolio manager. And now, turning over to Seven, could you guys talk about the current pipeline, what properties you guys are seeing, and just the overall health of the market?
Sure. So thank you, Matt, and thank you everyone for joining us here today, and for those of you on the webcast, thank you for listening in. Appreciate the audience today and the ability to be here. So, as far as current pipeline and things, I would tell you that we continue to review a significant number of transactions. I mean, average monthly volume that we register probably approaches about $1 billion. And there has certainly been a little bit of a sea change, I guess, in transaction types and transaction volume that has happened through this period of increasing interest rates and now elevated interest rates. We are seeing much more, I guess, on the refinance side than we are on the acquisition side.
I think that overall, we're seeing less trades happen in the marketplace. I mean, year-over-year trades for Q1 were down 19%. For 2023 over 2022, I think they were down almost 50%. So there's been a significant decline in actual transaction activity, related to sales. We are seeing elevated refinances for folks that need to refinance their current debt. Maybe their loans are coming due, and they need to... They need to extend, or, or, or to replace that capital with a new lender. So, while we're active, we are selective. Many of our peers in the mREIT space certainly were not writing many loans over the past twelve months, but, again, we have been active.
We've closed a couple loans this quarter, and, you know, we expect, you know, several more transactions kind of through the end of the year. As far as product types that we're looking at today, you know, we continue to focus on multifamily. We continue to focus on industrial. Hospitality is performing quite strongly right now, so we certainly like that space. We like the self-storage space. You know, retail, food and drug, neighborhood necessity-based retail, we think is still a terrific place to be lending capital. So, so we've been active in all those sectors. There's certainly been some headwinds. You know, with multifamily, we've seen declining rent growth in some cases, negative, but the long-term prospects there are quite strong.
You know, how construction starts are starting to decline dramatically, and that will, that bodes very well for the industry. Same thing with industrial. There were certainly been quite a bit of supply, but I think the longer-term trends are very positive there. So, we're optimistic, certainly about the future. We have capital to invest, and, you know, we look forward to, you know, continuing to write accretive loans here.
Yeah, that's great. And then mentioning the capital to invest, I believe you guys have $93 million in cash, which is the highest you've held in some time, have ample capacity on the warehouse and credit facilities. You know, so can you talk about the portfolio growth and, you know, how you guys have been originating loans in this environment, and also the credit quality of your portfolio?
Yeah. From a growth perspective, you know, we're anticipating that we're gonna probably close in aggregate for the year, probably call it $190 million, almost $200 million. You know, our average loan size is about $29 million right now. We anticipate kind of in the back half of this year that we should be closing you know, we're modeling right now, I think through August, through the end of the year, kind of one new closing per month. And as I said, we've got two that are closed this quarter or just about closed this quarter. As far as credit quality on the portfolio, you know, the credit quality remains strong. All our loans are current. All our loans are 100% floating rate loans.
All our loans are current. There are no non-accrual loans. Currently, there are no five-rated loans, five being the, you know, the worst on a 1-5 scale. Portfolio quality, you know, averages, I think, I think we're at about 3 right now, right?
Correct.
In the portfolio. So we're comfortable with the portfolio as it stands.
Yeah, that's great. And then-
Matt, perhaps I'll jump in. I'll just add a little bit more here. In terms of, like, the rating distribution, you know, about 71% of our loans are rated three, 15% of those loans are rated four, and about 14% are rated two. So, you know, pretty strong there.
... Yeah, and then can you talk a little bit about the yields that you guys are seeing right now, the fees, and kind of how spreads are going? And also the competitiveness to go out and win loans now, given that the banks are gone, and there's also a lot of money on the sidelines around the middle-market lending.
Yeah, I wouldn't say. You know, the banks aren't gone per se, but banks have certainly pulled in their horns, the regional banks, certainly anyway. What we're seeing across our portfolio, the average spread right now is about 377 basis points. The competition for new transactions is quite strong, and because there's a smaller universe of transactions that all the lenders want to lend on. So when you find one that works, the competitive nature is such that it's... Lenders are bidding very strongly. So there has been some spread compression in the marketplace. You know, with that has come some spread compression from our capital providers, our repo facilities, and our note-on-note facility lenders as well.
They've also felt the same thing, so they've started to come in on pricing, which is nice to see. So I think you know, the 377 basis points is 'cause the current average. You know, I think the last handful of deals were done on a blended basis to, you know, inside of that, maybe 20 basis points.
Gotcha. Yeah, and then, you know, touching on the funding markets and the repo there, can you talk about how that market currently and, you know, the counterparty strength that you guys have at the moment?
Yeah, sure. You know, we have four facilities, financing facilities. Citibank, UBS, and Wells Fargo are repos. BMO is more a note-on-note. The relationship with them is pretty good. We actually continue to show them product. They continue to look at our product, whether it's self-storage, whether it's student housing, whether it's multifamily or hotels. So, we do have ample capacity, as Tom alluded, so it's still open. They're still in business.
Yeah. That's great. And then can you talk a little bit about your leverage, and where you would ideally like to sit? And then, you know, if you would like to take it up, when and how would you do that?
Yeah, we're currently at 1.6x leverage. You know, ideally, if we were to increase our, you know, our loan underwriting, bring it up to about $800 million in total commitments-
Mm
... leave ourselves some room for total commitments going forward. You know, we could go up to about 2.2x-2.3x leverage.
Yeah.
That's about where we would be comfortable with the leverage.
Gotcha. And then turning back to the portfolio, you know, given the high rate environment, there are borrowers that are struggling. You know, and some people have had to take back properties. I believe you, you guys have one at the moment, but can you talk a little bit about how that process works and your capabilities if you do have... if that, if that does end up happening?
Yeah, I think you're right, Matt. We have taken back one property. We took back a property mid last year, an office property that we had outside of Philadelphia. Really, one of the biggest strength of our platform, especially relative to our size, is as our manager, the RMR Group. So, because they manage and own real estate, really all facets, industrial, hotels, now a multifamily platform, retail, we have-
Office, certainly.
Healthcare, industrial, yeah.
Yeah, right. So we have this depth of knowledge, this deep bench that we can call upon, just to get market intel when we're looking at a transaction, right? So we can certainly chat with the folks on the hotel side and say, you know, "What are you seeing in this particular market? What are the numbers looking like?" And we can use that as we evaluate a transaction. And sometimes that helps us win a transaction because we're sensing something maybe the rest of the market isn't, so we go very aggressively after that particular transaction, or maybe it goes the other way.
We learn something that's detrimental to the asset, and we say, Okay, we're just not. We're a no-bid here because of what we know. So that kind of works, from a loan perspective, that works very well for us. In the case of the... We had to take back a property, right? That was fairly seamless for us because we were able to involve our asset services teams, which managed this portfolio of office properties, right? They were able to take over the management of the asset. They were able to continue, really no disruption to the tenants, work with the existing leasing team, put forth a new business plan for the asset. And in that case, the property is performing quite well and is generating, positive cash flow, which, you know, contributes to our distributable earnings.
So, no lender wants to take back properties. If we need to, in an effort to protect shareholder value, we can certainly do that. We're not afraid to do it, and I think we can generally come out of the other side of that in a with a win for everybody.
Mm-hmm. Yeah, that's great. And touching on that relationship, you know, do you feel like there have been any insights or, I guess, trends that you guys have been able to identify or are leaning into, you know, at the moment that gives you a little bit of a competitive edge there?
Well, I think certainly with the, again, with the knowledge that we have internally, it certainly has helped us on the hospitality side. We wrote a couple of nice hospitality loans last year. I think we were able to look at those markets and draw on the expertise that we had, from the folks that are managing the hotels, in our equity REITs, and that's super beneficial to us.
Yeah.
And it helped us make some really informed decisions, and those loans have turned out quite well and are actually two of our lower-rated loans. Lower rating, meaning better rated.
Mm-hmm. You know, are there certain pockets of markets that are seeing, you know, outsized strength, outsized deal flow, or ones that you guys really are trying to get into at the moment?
Geographic markets?
Yeah, yeah.
We lend nationwide, and we will certainly continue to. We have never been a significant Gateway City lender, meaning Manhattan, San Francisco, you know, those—for right or for wrong, we either, when the market was super hot in 2020 and 2021, right, we probably weren't just more competing there. But too, those tend to be much larger transactions. Again, we're middle market, so we're in that $20 million-$75 million bandwidth of capital. And you'll see much larger transactions in those markets.
Yeah.
So those are some of those markets are the ones that we just don't play in. I would tell you that we're much more capable in, you know, in a Dallas, you know, in a Columbus, Ohio, and in Indianapolis and, you know, in a suburban Chicago and, you know, those types of markets that those just they're more middle market, so they fit better with our source of capital.
Right. Right. And then turning to the supply there, you know, do you think that there's gonna be a given point in time where the market kinda comes back to normal, and it's, it's a good supply-demand balance? Like, where do you think it is at the moment?
Supply-demand for...?
Just originating.
Just originating loans.
Up on the market.
Look, what the market needs right now is simply stability. Everybody needs to know the rules of the game. Interest rates, while elevated, are not crazy high. I mean, these aren't interest rates that are 10%, 12%, 14%, right? They were at 0%, and now we're at just over 5.25% on the short term. So, the problem there was they went up just too quick, and people couldn't earn their way out of the interest rate increases, right? They couldn't create enough value to offset that.
But if we get some clarity that the Fed may begin to ease, we get a 10-Year Treasury that doesn't vacillate 40 basis points every other week, and people start to have confidence of how to finance their projects, I think we'll start to see transactions, right? At the same time, we need to see the banks, in particular, you know, ask their borrowers to now pay off their loans and go seek financing elsewhere. That may require sales, right? So once we start seeing asset sales again, 'cause the banks say, Okay, we can no longer extend you, sponsors need to make a decision. They can't refinance without putting in cash.
They don't wanna put in additional cash, so the only avenue there is going to be to sell the asset. And once you sell the asset, then there's a new basis that's set. Lenders are comfortable coming in there at a reduced basis or at the new basis. New equity is comfortable coming in at the new basis, and then we're gonna start to see more transactions. And we think that's going to happen here towards the end of the year. We thought it would happen earlier this year, but frankly, I think just a lot of... there was just a lot of extend and pretend last year. We kept hearing that phrase, and that's really what happened with the banks. They just let the borrowers kinda hang around a little bit longer.
But we're seeing that start to come to an end.
Yeah. Yeah, that's good. And, you know, following up on the higher for longer scenario and the implementation of CECL that occurred recently, you know, could you talk about how you guys think about CECL reserves from a portfolio perspective and then from an asset-specific perspective?
Sure. Happy to take that. You know, just to kinda give some color in terms of the CECL model, we actually, like many of our peers, work with Trepp. Part of the input into the model is macroeconomic outlook for the... You know, and we've seen that, at least on the CRE pricing, the outlook is negative. The economy might be looking a bit better. So that's one of the inputs that goes into the model. The other one is obviously looking at our portfolio, looking at operating metrics, both NOI and occupancy. Where are those trending, whether it's higher or lower? Obviously, improved occupancy, improved NOI, results in a lower CECL reserve. And then finally, we look at our loan maturities.
The longer the loan maturity, obviously, the more of a reserve that we have. So that's basically how the CECL model works, and the CECL reserve works. We have been operating at about 1% of total loan commitments. That was the last, the most recent quarter, but it has been fluctuating anywhere between 75 basis points and about, you know, 1%. So, pretty, pretty conservative, pretty strong metric, I guess, compared to most of our peers.
Mm-hmm.
And again, we have no problem loans, no non-accrual loans, no specific reserves 'cause we have no five-rated, five being very bad or worse rating, at this point.
Yeah. Yeah, that's great. And then could you talk a little bit about, you know, why, I guess, you've seen that strength in your portfolio, on the credit side? And then also, can you touch on the maturities a little bit and, you know, what you're expecting to pay off this year, next year, and then what it kinda looks like from a fully extended basis?
Well, I think the quality of... You know, we can toot our own horn here a little bit. On the quality of the portfolio really, I think, is just partly, significantly in part because of our underwriting team and how we look at real estate and given the depth of experience that we have in real estate, just allows us to make what I believe are, you know, very informed decisions. So I think it's... We've also, from a sponsorship perspective, you know, our sponsors generally are not syndicators.
We were never heavily involved in a lot of the syndicated equity, crowdfunded equity, which those sponsors are now having problems because they're not able to go back to their investors to get additional capital to solve some problems. So I think our quality of sponsorship is high. And again, I think our underwriting has been very strong from that perspective. And I'm sorry, the second part of the question?
The maturities profile.
Oh, so maturity profile.
Yeah.
I think we're looking at, I think we have 10 loans coming?
Yeah, 12 loans actually maturing this year. Out of that, six are going to... We believe they're gonna be repaid, and the other six, we believe, are gonna be extended.
Yeah, so that's probably about $120 million or thereabouts that'll come back in the form of a repayment.
Mm-hmm.
And then the balance will most likely be extended.
Gotcha. Yeah, and then, you know, with those payoffs, how are you thinking about liquidity versus going out there back into the market and putting that money to work?
Well, we're again, we're actively looking to put capital to work. So, you know, we've conservatively modeled one loan, I think just one closing per month, August through December, at an average of about $29 million. And based on the current availability underneath our financing facilities as well as cash, if we receive any other, you know, elevated payoffs from loans that are not maturing this year, which is certainly a possibility, you know, we would look to invest that capital as well. So, I would say that we're on offense. I don't think we're. We always want to maintain some liquidity in today's environment. I think it's critical. But I think that, you know, the plan is certainly to continue to grow the book.
Mm-hmm. Yeah, that's great. And then kind of switching gears here, you guys have had ample dividend coverage recently. I believe you raised it within the past year as well. Can you talk about the strength there and, you know, just that, just that-
Sure.
-in general?
Sure. So the dividend is $0.35 a quarter, about $1.40 a year. Currently, you know, giving, you know, fluctuations in the stock price, it's about an 11%, yield, dividend yield. We feel comfortable with the level of the dividend at this point. It's covered by distributable earnings. You know, last quarter, we had about a couple pennies of coverage above the dividend, and same as the prior quarter as well. So we've been, we've been pretty strong. I think at this point, we're comfortable where the dividend is. Obviously, that is a decision of the board, but we're comfortable where the dividend is right now.
Yeah, that's great. You know, and I guess going back to the portfolio, you know, is there any property type specifically that you guys either want to really get into or really avoid at the moment? I know that that office has kind of been the problem child for the past couple of years, and it's probably not gonna get better anytime soon. But, you know, how are you guys thinking about that and the portfolio diversity that you guys are able to build?
Yeah. So the portfolio is fairly diverse. I mean, our largest percentage is multifamily. I think we're 35%-36% multifamily, followed by industrial, and then office is in there as well. So office right now, I think, is 28% of the portfolio. That's down from almost 35% or thereabouts earlier. We've continued to manage that lower. We now have six office loans versus 10 at the beginning of 2023. 3 of those loans currently are rated a four, the other three are currently rated a three. They're all again, they are all performing, but I would tell you that from a property type that we're trying to avoid, I think that, you know, there, there's probably opportunistic situations in office today to lend on.
However, I think at this stage, we're kind of letting this continue to play out a little bit further before we dip our toe back into office. But other than that, I would tell you that there's really all the other product types are certainly available for us to finance.
Yeah. Yeah, that's great. And then could you talk a little bit about the ideal loan, you know, what the LTV is, the kind of fee structure there, you know, what you guys try and underwrite to?
Sure. So ideal loan for us is probably a $30-some-odd million loan. Generally, it's gonna be a 3-year loan with two one-year extensions. It's priced, you know, SOFR 350, something along those lines. Generally, it's a 1% fee coming in, and there may be an exit fee on the back end, anywhere from 0.25 point to 1 point. It just depends. I mean, sometimes we'll often do maybe a little bit lower spread, but increase the fees on the back end to help take some of the pressure off of the debt service that the mortgage payment that the sponsor's gonna have to incur. So that's helpful. We're generally sizing to a return on equity when we leverage our position, you know, call it 12.
You know, the range is probably 11-14.
Mm-hmm.
You know, but we're good in that low double-digit number from a, from a return on equity perspective. And generally, from a sponsorship standpoint, you know, who our borrowers are going to be or who the sponsors are ultimately behind the borrower, you know, we're looking for individuals that certainly have executed on this business plan before. Sponsors that have liquidity and have skin in the game, so they're putting their own capital into these transactions in addition to whoever their, their limited partners may be. Oftentimes, we're seeing LPs in these transactions. Maybe it's high-net-worth individuals, or it might be a family office, and or there might be some institutional capital there. Again, we're trying to, you know, avoid the syndicated model, if you will.
Mm-hmm.
But, you know, again, looking for high quality, high character sponsors that have done this before, have liquidity. These are non-recourse loans, so we certainly want the ability for the sponsorship... You know, we like to say that we want the sponsorship to be able to write a check or have the ability to write a check to solve a problem, you know, if they choose to do that. So, so sponsorship is key, you know, as, as well as obviously the quality of the real estate.
Mm-hmm. Yeah, that's good to know. And then within the current portfolio, you know, do you have rate caps in place? I guess, what percentage, and then, you know, with the new originations, you know, how are sponsors kind of taking that?
Yeah, look, nobody wants to buy a rate cap, and, rate caps are expensive. The portfolio right now, I think all but one loan has a rate cap currently. In that particular situation, they posted cash in lieu of the rate cap, meaning they, just simply didn't want to buy the cap because they were-- they felt that, you know, rates might be coming down, right? And then they would be out of the money, and they wouldn't be getting any benefit for that cap. So what they did instead was put up a cash collateral account, to be drawn upon if necessary. But, as a general rule, we do require caps. Our counterparty lenders, you know, require us to require our sponsors to have caps.
You know, it's a beneficial tool, and it certainly has, you know, as we saw it during this rate increase environment, you know, we have sponsors that have caps at 50 basis points , 75 basis points . They're making a significant amount of cash flow from that financing vehicle.
Mm-hmm. Yeah, that's great. You know, and one thing I do want to add, I forgot to add this at the beginning. Jones does have a buy rating on Seven Hills with a $15 target. Total return as of yesterday's close is about 27%. You know, your stock has performed very well over the past year with, I believe, about a 54% all-in total return. You know, I guess why do you think that is, and, you know, how do you think you guys continue that?
Well, I think it's in part because I think the market looks at our portfolio and says, Okay, these guys are-- they've managed this very well, right? I think they're looking at the coverage on the dividend. The fact that we were able to raise the dividend, I think we raised it in February 2023, right? And it remained constant at that stage. So it's a well-covered dividend. I think we've got a terrific story to tell. We have liquidity, we have capacity, the loan book is in great shape, and we have the skill set to continue to, you know, to grow this business and manage this portfolio. So I think folks look at us and they see the kind of the depth behind us.
It's not simply a mortgage portfolio, but it's a wealth of real estate knowledge for—if we do have to get in there to protect shareholder value and take back a property, we can do those things, and I think the market is starting to react favorably to that.
Yeah, that's great. You want to open it up to questions or any closing remarks?
Sure. Yeah. If there's- That works.
Anybody have any questions for Seven Hills?
Just back on the dividend, you talked about the coverage. Can you talk about your growth plans for the dividend and what your growth policy will be if you continue to ramp up your volumes?
Yeah, for those on the webcast, just talking to Jay's question about the dividend, consistency of the dividend and the possibility of increasing the dividend. I guess I got that right, Jay?
Right. And the growth of the business plan as well. So we're currently, like I mentioned earlier, $0.35 per quarter, $1.40. We are comfortable with the dividend right now, Jay. As we continue to ramp up, we would evaluate that, but currently, we just wanna get the capital that we have available and put it to work and then just evaluate, see where the business plan is. You know, but for now, we just wanna be conservative with the dividend. Yep.
And do you have any feel yet—I know it's early in the year, but for where the dividend comes out with respect to taxable net income and the 90% rule to maintain your REIT status, that if you're in a position where you have to raise it because your business is growing?
We would evaluate that, of course. We were in that situation at the end of 2023
where we were exceeding, obviously, our, you know, our DE, our distributable earnings was much higher, but we didn't have to do that distribution, special distribution. So as we go forward, based on the model that we're looking at, you know, we don't expect to be as high in terms of a DE. Obviously, we will be covering the dividend, over covering the dividend, but at this point, we will have to evaluate as we get closer to year-end.
Yeah.
Hi, Steven Wallace, Raymond James. Just, you mentioned earlier six loans likely will be extended this year. Can you talk about that process? You know, will you renew rate caps? Do you think they'll lose cash, cash instead? Any concentration among those six, either by property type or same sponsors are having multiple loans?
Of those six that we think will extend, four of those are probably office. I believe two of them are multifamily. The two with multifamily, that is the same sponsor between two separate transactions. And as part of the - when we look at these extensions, there's built-in extensions if they hit the certain credit metrics, right? So if they hit a certain debt yield or a certain coverage, that's kind of an automatic extension, I mean, somewhat perfunctory. Otherwise, it becomes a discussion, and when I say it's a discussion, generally what we're seeing in those situations is the sponsors coming to the table with some cash to kind of rightsize the transaction. It may not - it may be...
It could potentially be a paydown, or it could just be additional cash that's posted for debt service reserves or additional TIs or CapEx, whatever, you know, whatever the asset may need, and they're putting capital back into the asset. So we're comfortable with that business plan. So I would tell you within all those discussions that we're having, something's coming from the sponsor, as a general rule. And we're making sure that there's an exit plan in place, right? That we all agree that, Hey, look, if you get to this milestone, we're all in pretty good shape. And that's how we certainly look at things. I would tell you that we speak 'cause we asset manage all our loans, right?
So we are speaking to our sponsors if it's not weekly, it's bi-weekly. So it's especially as it relates to office, everybody, our sponsors are very transparent with us. We're very transparent with them on what we're asking for and what we expect of our borrowers. So I think it's a very good working relationship, and as long as both parties are communicating very well and they're being transparent, you know, you can work through these, you know, these short-term issues that you have in the marketplace.
Thank you.
Anything else?
That's it.
Well, thank you very much, everybody, for coming in and-