Wells Fargo Upgrades KKR Real Estate Finance Trust: 3 Reasons Why

Even as analysts are divided on the near-term outlook for the housing market, Wells Fargo Securities saw fit to upgrade KKR Real Estate Finance Trust Inc KREF Wednesday. 

The Analyst

Analyst Donald Fandetti upgraded KKR Real Estate from Market Perform to Outperform with a price target lifted from $20 to $22.

The Thesis

KKR Real Estate is gaining traction by leveraging KKR & Co Inc KKR for both originations and unique financing vehicles, Fandetti said in a Wednesday note. (See the analyst's track record here.)

"While KKR is not historically as big in [commercial real estate] as some peer private equity firms, their relationships are deep and can support originations and provide market reconnaissance," the analyst said. 

The 20-percent quarter-over-quarter net portfolio growth in the second quarter of 2018 and heavy volume so far in Q3, along with the move toward targeted leverage, should close KREF's EPS-to-dividend gap, Fandetti said. 

The analyst said he expects the multiples of commercial mortgage REITs to expand as equity markets begin to discount spread tightening in the debt markets. Origination volume remains robust and the U.S. GDP is improving, he said. 

Despite banks providing better borrowing terms, Fandetti said loan spreads have continued to tighten on transitional floating-rate CRE loans. The spread tightening is an indicator of strong demand for the product, which will ultimately be reflected in high stock valuations, he said. 

The lending market remains healthy despite a rise in the 10-year Treasury yield, Fandetti said. 

Wells Fargo expects a potential sharp increase in the 10-year Treasury yield to negatively impact yield stocks. And broader credit market spread-widening events could pressure the stock, offering good buying opportunities, according to the sell-side firm. 

"Combined with the 8.4-percent yield, we see mid-to-high-teens total return potential," Fandetti said. 

The Price Action

KKR Real Estate Finance Trust shares were rising nearly 2 percent to $20.84 at the time of publication Wednesday. 

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