Claros Mortgage Trust, Inc. (NYSE: CMTG) is focused primarily on originating senior and subordinate loans on transitional commercial real estate assets located in major markets across the United States—a strategy that has served the REIT well since its founding in 2015.
Transitional commercial real estate assets are properties that require repositioning, renovation, rehabilitation, leasing, development or redevelopment, or other value-added elements, in order to maximize value.
More recently, the company has been diversifying its portfolio both in terms of geography and property type in response to evolving demographic changes that have only accelerated since the pandemic began.
“We strive to create a diversified investment portfolio of commercial real estate loans that we intend to hold to maturity,” says Richard Mack, CEO and chairman of the New York-based company.
Claros started under the Mack Real Estate Group (MREG) platform, though the history of the business lies on the foundations of a number of earlier businesses, Mack says, explaining that his The Highlands-Evo; Arlington, Virginia family been in the commercial real estate industry for three generations.
“In 1991, my father was one of the original backers of Apollo Global Management, which was focused on junk bond debt,” Mack says. In 1993, Apollo turned to real estate. “I had been a banker in the late 1980s, went to law school, and my father convinced me to join him in what would become an independent business, first under the Apollo Real Estate name and later AREA Property Partners. One $500 million fund led us to invest and raise about $14 billion in equity and do about $70 billion in transactions by the time we exited that business.”
Mack became CEO of AREA’s North American business and a member of that firm’s U.S. and European investment committees. When the Mack family sold AREA in 2013 and founded MREG, they retained a property management company, as well as a small hedge fund that traded primarily in CMBS securities with a view toward remaining active in both real estate equity and debt as warranted by market conditions.
“Our idea was to start out creating Class A multifamily to hold on a multiple generation basis and to build assets ourselves via the development and property management infrastructure we had retained from the sale of AREA,” Mack says.
The firm quickly expanded on the debt side, launching Claros in 2015.
“With a fully integrated platform—one that included a lender, a developer, and a property manager— and a very strong debt track record from our lending success at AREA, we were uniquely positioned to capitalize on the market opportunity,” Mack says.
Steven DeLaney, managing director of equity research for JMP Securities, has a favorable view of Claros in large part due to the capabilities and reputation of the REIT’s external manager, MREG.
“While many mREITs are managed by large asset managers, MREG brings decades of real estate development and construction expertise gained across various market cycles,” he says. “This expertise allows Claros to invest in certain more complex financings that provide higher returns on invested capital than the traditional bridge loans favored by most commercial mREITs.”
Claros had a successful IPO on the New York Stock Exchange in November 2021 and today the company is one of the largest public commercial mREITs in the U.S., based on total stockholders’ equity, closing out 2021 with a $6.6 billion investment portfolio.
Claros operates with an investment philosophy of being a true capital partner to borrowers, underwriting complex business plans to provide flexible financing solutions that are highly responsive to borrowers’ needs. This approach also enables Claros to hold borrowers accountable for achieving agreed-upon milestones.
Operating under what Mack characterizes as “some pretty strong philosophical guidelines,” at the outset of Claros, the strategy was to lend on assets that it would be comfortable owning at its loan basis in markets that MREG understands and where it had significant experience.
A frequently cited principle of the company’s investment process is to target appropriate “execution risk,” given the capabilities of the MREG platform to step into the ownership chain, if necessary, while avoiding “basis risk,” or the risk of over-lending.
“We’re also very careful about sponsorship because we look to make large, complicated transitional loans, with the average loan size today around $120 million,” Mack says. “Because these loans are so large, they tend to have strong institutional sponsorship, so we are essentially intermediating between the banks.”
In other words, it’s more capital cost effective for them to participate with Claros, leveraging its balance sheet or providing senior financing and loans than it is for the banks to make the loans themselves because developers still want 60-80% financing and banks are not able or willing to finance that entire risk.
“That allows us to service a niche—a very big niche in the market—by providing transitional capital,” Mack says. “We understand our borrowers’ businesses and, if there are problems, we have the expertise and capacity to find solutions and work with them because we have such a dynamic asset management team and broader organizational capabilities.”
Over time, the strategy has shifted a bit both in sentiment with population and economic development in the U.S., and also coincident with its equity business.
“As demographic and economic shifts have moved away from places like New York City, San Francisco, and Los Angeles towards markets in the Sun Belt, our business has shifted with that,” Mack says. “We have also observed many developers who have moved their activities into these markets following economic growth.”
Mack admits the company was conservative in reserving cash during the early stages of the pandemic, and could have ramped up new originations sooner, but he doesn’t regret the defensive mindset. This approach ultimately sets the company up to come out of the pandemic in a very strong position.
As Claros entered 2022, the company has seen the chance to take market share away from collateralized loan obligation (CLO)-based lenders. Given that, it’s taken the opportunity not just to diversify geographically, but also to move down the risk spectrum to lighter transitional loans and to take advantage of what it sees as relative value in the capital markets.
“We’ve been most aggressive in the lowest-risk assets, which has been multifamily, over the last six months,” Mack says. “We positioned our book very defensively, looking to higher-growth areas and really sitting in a very good position to take advantage of increased dislocation given how much cash we now have and given that heavy transitional spreads seem to be increasing pretty dramatically right now.
Claros is set up nicely for the second half of 2022 as it continues to diversify from New York and Los Angeles, which historically saw 40% of its transactions.
“We’ve been focused on markets that continue to demonstrate strong growth, such as Dallas, Miami, Phoenix, Seattle, and Nashville, and it has been instructive to follow the lead of our equity business into many of these markets,” Mack says. “Deploying capital in these markets has resulted in enhanced portfolio diversification with stable asset values in this rising interest rate environment."
For instance, Phoenix, which was a secondary market, is an area showing great economic growth, and one that Claros is already working in. The same holds true for Miami.
“What’s really been different for us is our geographic move into Texas, which has really been driven by the major cities there,” Mack says. “Then there’s Seattle, which has been a big development market for our equity business and playing a bigger role in our debt business."
Jade Rahmani, managing director of commercial real estate finance for Keefe, Bruyette & Woods, notes while the company’s earnings were below expectations for the first quarter, what was interesting to him, is that post-quarter end, they resolved one of its nonaccrual loans at 27% above their principal, which result in a 22% per share gain.
“This is an example that really validates their thesis, that they are going to have good credit outcomes,” he says. “They are not immune to having loans become non-performing, but they have used structure in their deals more so than peers. This development in the first quarter has me feeling positive about the management team and their strategy."
DeLaney is bullish on Claros’ strategy going forward, noting commercial mREITs largely invest in floating-rate loans indexed to LIBOR or SOFR, which increase in periods of Federal Reserve tightening.
“All other things equal, the commercial mREITs should generate higher earnings in a rising interest rate environment, which is a significant factor behind our higher EPS estimate of $1.61 for 2022 compared to the $1.27 earned in 2021,” he says.
With an experienced management team that brings extensive equity and credit investment expertise, along with several decades of experience investing through multiple economic cycles, Claros is poised to continue growing in the future.
“Our unique value proposition is that we started as property owners, managers, and developers, and we really understand the asset class,” Mack says. “We’re also capital market savvy, and just because we are lower levered, doesn’t mean we don’t under stand the capital markets. Our decision to be lower levered is because we do understand them.
Of its current $7.2 billion loan portfolio, 97% are floating-rate and 96% are senior loans.
The mREIT has also been active in the build-to-rent space, and is a life science lender as well. The firm is very active lending against cash-flowing multifamily.
“While there are a range of opinions about what may unfold in the coming year, we believe there will continue to be attractive investment opportunities in transitional real estate lending for well-capitalized and scaled lenders like us,” Mack says.
Short-term rates and lending spreads are rising, Mack adds, providing an opportunity to increase earnings. While this usually creates real estate value reduction, he says, “at this moment rent inflation is also increasing, keeping asset values stable to up in the high-growth markets and asset sectors where Claros has the greatest exposure.”