Downgrades Flood In For Commercial Real Estate Stocks: Analysts Warn Of 'Rocky Road Ahead'

Bank of America has downgraded six players in the Commercial Real Estate (CRE) mortgage REIT sector, citing interest rate headwinds and weakening fundamentals that spell a “rocky road ahead” for the industry.

Eric Dray, CFA, a research analyst at Bank of America, conveyed in a note to clients on Monday that the sector might see a downward trend in book values and sustained tepid investor sentiment over the coming quarters.

“The office sector has faced headwinds from slow return-to-office in the U.S.,” according to Bank of America, as evidenced by a minimal effective rent growth of just 0.5% year-over-year in the fourth quarter of 2023, coupled with a climb in vacancy rates to 19.6%.

Bank of America’s Downgrade Decisions

Several mREITs have been downgraded by BofA, reflecting the anticipation of persistent sectoral pressures:

• Ares Commercial Real Estate Corp. ACRE: Downgraded to Underperform with a new price objective (PO) of $7, down from $11. Notable concerns include a significant office exposure and looming portfolio maturities, alongside recent credit issues and a dividend reduction.
• Apollo Commercial Real Estate Finance ARI: Downgraded to Underperform with a $10.50 PO. The firm faces risks from upcoming high-profile maturities and narrow dividend coverage, suggesting potential for further dividend cuts.
• BrightSpire Capital Inc. BRSP: Downgraded to Underperform with a $6.50 PO, given its exposure to pressured sectors like US office and sunbelt multifamily properties, despite recent portfolio credit improvements.
• TPG RE Finance Trust Inc. TRTX: Downgrade to Underperform, with a $6.50 PO, up from $6.00, following a significant portfolio reduction and unresolved credit issues, raising concerns about future dividend sustainability.
• Starwood Property Trust STWD: Downgraded from Buy to Neutral, with a $21.50 PO, down from $22.50. The diversified portfolio with limited office exposure represents a positive factor, but there is little visibility over upcoming maturities.
• Blackstone Mortgage Trust Inc. BXMT: Downgraded from Buy to Neutral, with $21 PO, down from $22. On the plus side, borrowers and sponsors have continued to invest in the properties, but elevated office exposure, high leverage and substantial near-term maturities represent major concerns.

Risks Ahead

“CRE fundamentals remain shaky and as rates stay higher for longer, we think pressure will mount on CRE mREIT portfolios,” Dray highlighted.

The analyst highlighted that floating rates are the normality among CRE loans. The rising rates threaten property values and refinancing capabilities, potentially leading to an increase in defaults or forced equity injections by borrowers.

Despite the current discounts in CRE mREIT shares, BofA’s analysis suggests that the risks are skewed towards further downside. The office sector’s deteriorating fundamentals, coupled with high leverage levels used by mREITs, could amplify the impact of problem loans, potentially depressing book values further.

Market Reactions

• Shares of Ares Commercial Real Estate Corp. fell 3.2% on Monday, extending their year-to-date decline to 28%.
• Shares of Apollo Commercial Real Estate Finance tumbled over 4% to $10.29.
• BrightSpire Capital Inc. saw its share price tumbling over 5%, on track for the worst session since early August 2023.
• Both Starwood Property Trust and TPG Re Finance Trust Inc. eased 2%.
• Shares of Blackstone Mortgage Trust Inc. fell nearly 3%.

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