Owens Realty Mortgage (NYSE: ORM), a small balance commercial mortgage lender, is actively looking to increase liquidity for commercial lending activities through strategic disposition of real estate assets.
The REIT’s average loan size is about $3.5 million, and its loans fall in the $1 million to $20 million range. Based in Walnut Creek, California, most of its lending is in the Western U.S., with 75 percent in California alone.
Following the 2008 economic downturn, the company found itself saddled with real estate that it had to foreclose on at a discounted rate. Since then, the mREIT has been working to dispose of property holdings that are a drain on cash flow in a timely and efficient manner, but also on the best terms possible for the company.
Bryan Draper, Owens’ CEO, expects to be mostly through with this process by the end of 2019. Not only will this provide Owens with more opportunities to lend, he says, but the company will be better positioned for possible mergers and acquisitions.
Ben Zucker, a New York-based JMP Securities analyst, agrees. “We are seeing a lot of capital raising in private debt funds. This might be an attractive way for one of those debt funds to get a permanent capital vehicle. It’s a turnaround story,” he says.
Considering that the properties have appreciated since the financial crisis, and the company has to carry the properties at cost, Zucker sees some embedded value in the company—currently at about $22 book value per share—that is not reflected in its market price.
Warding Off the Activists
This discrepancy in value caused friction with Freestone, a major Owens shareholder that turned activist. Freestone was demanding the liquidation of the company, something the Owens management and the board of directors was not prepared to do. That led to Owens recently buying out Freestone’s approximately 8 percent stake in the REIT at $19.25 per share.
“Freestone said liquidation or nothing, and was very adamant and very public. Due to the fact that the cost associated with fighting the battle would be so substantial, the board determined that buying back the stock was in the best interest of the shareholders,” Draper says.
The stock, which was listed in July 2013 and closed at $9.20 on its first day on the NYSE MKT Exchange, was trading in the $14 range at mid-March, following the announcement of the REIT’s fourth quarter 2017 results. For the period, the REIT reported a net loss per share of $0.44, and income per share of $0.85 for the full year 2017.
According to Zucker, “Earnings should not be the go-by for this company. It should be about where you think the book value settles once they realize all the gains that have been embedded in the portfolio.”
Prepared for Rising Rates
Anther potential issue for mREIT investors is the specter of rising interest rates. Even though most of its loans carry a fixed-rate, Draper expects that the typical one-to three-year term of its loans gives it enough leeway to tackle rising rates.
The company is now changing its terms so that loans extending beyond a year will reset as variable-rate loans. “Having a fixed-rate on their loans is very important to many of our borrowers and instrumental in us getting the deal. However, we’ve found out often through the years that they are not able to pay us off as quickly as they might have thought, so we like to build interest upside into that,” Draper says.
While there has been some short-term compression in the company’s spreads, Draper expects that the rising rates on loans Owens makes will offset its rising borrowing costs.
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