As a committed, passionate, and experienced REIT analyst, part of my steadfast research includes observing principles I can rely on time after time, to deliver alpha and deliver results – and then, share my findings. That’s part of why I present these columns in The Property Chronicle.

Today, I want to illuminate a principle of competitive advantage. One way of saying this, is knowing how to “play the system.” But that’s too ordinary for me, and borders on a lack of integrity. I much prefer “using the system.”

Here’s an excellent example in the REIT marketplace of such a competitive advantage. It’s one that can provide readers with a valuable investing insight – and highly sustainable dividends.

Blackstone Mortgage Trust (NYSE: BXMT) is a REIT that primarily originates and purchases senior mortgage loans collateralized by properties in the U.S. and Europe. The New York-based REIT is managed by “big brother” Blackstone (BX), a world leader in alternative investments with nearly $440 billion of assets under management (AUM).

“Big brother” BX operates with significant scale in each of the four key alternative categories: Real Estate ($119.4B AUM), Private Equity ($119.5B AUM), Credit ($123.1B AUM), and Hedge Fund Solutions ($77.4B AUM). And that $119.4B number makes BX one of the world’s largest commercial real estate investors.

Around three years ago, “Little Brother” BXMT completed an equity offering, raising $660 million in growth proceeds – a strong indication of the growth potential of the simple floating rate senior mortgage business plan. Limited new commercial real estate construction, coupled with modest growth, has led to a more favorable investment environment for senior commercial real estate debt.

BXMT’s relationship with the “big brother” (Blackstone Real Estate) offers a huge advantage in which the former’s access to proprietary deal flow and property and market information is a valuable differentiator, given the scale of BX’s real estate business.

As part of Blackstone Real Estate, “little brother” BXMT is uniquely positioned to obtain market-leading credit opportunities. The low cost and superior structure of financing enhance the returns on the REIT’s loans.

Simply said, BXMT’s connection to Blackstone Real Estate allows the company to benefit on both sides of the balance sheet. Blackstone Real Estate is a premier debt and equity investment and asset management platform.

BXMT is externally managed (most commercial mortgage REITs are, except Ladder Capital Corp. (NYSE: LADR)), and so, BXMT and BX are essentially the same management team. BXMT’s real estate debt people are the originators and asset managers for both BX and BXMT.

BXMT is the senior vehicle, but there are other vehicles at BX, managed by the same team, for different strategies which are not public. BX has access to deal flow, attractive financing terms (where the companies leverage the entire BX relationship with the banks), underwriting/asset knowledge, reputation and brand, etc.

As many readers know, I’m normally not a proponent of externally-managed REITs, but I pay close attention to the commercial mortgage REITs (“mREITs”) because I believe that they provide a valuable place setting for retail investors.

BXMT charges a 1.5% management fee on equity and a 20% incentive fee on gains above a hard hurdle of 7% (no catch-up gains below that), with a look back. General and administrative expenses (G&A) include management and incentive fees, as well as other G&A expenses for the REIT.

A simpler commercial mortgage REIT

I focus on REITs with lasting repeatability, and for me, dividend sustainability is the ultimate research metric. If I’m not comfortable with the durability of the dividend, I won’t recommend the stock. So why am I recommending this commercial mortgage REIT?

Economic conditions are sustaining a favorable commercial real estate market as liquidity and fundamentals in the commercial real estate sector are generally in balance. Real estate continues to benefit from limited supply and moderate growth.

The macroeconomic backdrop for commercial real estate fundamentals is sound, fueled by job growth and positive consumer sentiment; real estate operating fundamentals have continued to improve and supply has been limited in most markets and asset classes.

Commercial real estate fundamentals are improving, which further supports the business model for real estate lending. Reluctance among traditional commercial real estate lenders, coupled with increased transaction volume, creates a compelling lending environment. CMBS and bank lenders are reducing CRE lending activity under regulatory pressure.

Blackstone Real Estate (”big brother”) has proprietary insight, long-standing expertise and superior access to deal flow, and accordingly, BXMT’s affiliation with it is a great competitive advantage. In fact, the relationship is a valuable differentiator given the scale of Blackstone’s real estate business.

Keep in mind that BXMT does not own equity interests in real estate. Part of the value proposition for investing in the specialized commercial mortgage sub-sector is the limited new supply constraints – completions are well below US aggregate construction completion levels.

This strong commercial real estate environment, marked by healthy property transaction volume, gives rise to strong borrower demand for transitional capital. BXMT is one of the most elementary commercial REITs that exists.

More detail, if you like

BXMT’s short-term floating rate assets benefit from rising short-term interest rates, as their current yields increase with these rates. REIT investors tend to fear rising rates, particularly investors in residential mortgage REITs, where many of the assets are fixed rate, but the liabilities float – but BXMT is different. Around 92% of loans are floating rate (earnings would benefit from increased short-term rates).

The company’s loans are LIBOR-based and insulated from the valuation impact of rising rates. Its credit facilities are also LIBOR-indexed and match fund assets. As a result, equity returns directly benefit from increases in LIBOR. When rates rise in tandem with better economic activity, the real estate underlying the loans will generate higher cash flows.

The credit quality of BXMT’s portfolio remains strong overall, and you can read their entire Q2-18 results on their website.

BXMT has stayed true to its senior mortgage platform because it is the best value proposition for capital. Unlike other peers (i.e., Starwood Property Trust (NYSE: STWD) and LADR), the company’s earnings are not predicated upon trading or securitization activities.

BXMT has continued to produce strong results because of its singular focus on originating senior mortgage loans efficiently financed to maximize ROI. BXMT financed $3.5 billion of loans in the first half of 2018 at an average rate of LIBOR plus 168, but has expanded and improved its bank financing.

BXMT also continues to silo large loan CMBS and syndications to assure the most efficient senior execution for loans. The scale of quality of best-in-class capital markets initiative matches BXMT’s origination capability. It also benefits in the “big brother” platform, and it’s a great track record as a borrower and banking client.
BXMT’s portfolio growth is supported by the right-hand side of the balance sheet, financing floating rate assets with floating rate liabilities and preserving positive correlation to increases in floating rates.

BXMT continues to focus on term and currency matched financing at low interest rates with no capital markets mark-to-market provisions, allowing the company to generate stable ROIs.

Year-to-date, BXMT has returned around 10%, with shares now yielding 7.3%.

The CEO speaks

I’ll close with a few good quotes from BXMT’s president and CEO Stephen Plavin on the competitive lending environment (from their last earnings call): “We’re still able to win deals that we like in the marketplace with what we think are very compelling terms. But this spread competition is pretty fierce out there. We really are benefited from some of the proprietary deal flow that we were able to access through the platform here, seeing deals that may be others won’t see. And also having the ability to do larger deals. They’re synergistic with what we own on the equity side, and as our capital base and liquidity grow, we’re even better suited than we have been in the past to do the larger deals, which are less competitive.”

And as for BXMT’s benefits from the “big brother” relationship: “We’re benefited by having being part of an organization, it’s a huge ownership footprint, in almost all of the markets that we’re active in as a lender. So we really feel like we have a unique perspective on what’s happening. We’re still seeing strong demand, a tenant demand and demand in general for almost all the asset types that we’re active in.

“Obviously, probably with the appropriate degree of caution. We also have the benefit of our business model really being built in toward the cycle. We have super stable liabilities, we have low loan to value loans, we have a lot of equity in the business and a great capability to anticipate, if problems are managed through them given, again, all the real estate expertise this past year.”

Well said.

Oh – and one big reason we cover commercial mortgage REITs in my Forbes Real Estate Investor newsletter, is so to help “read the tea leaves” in the equity REIT sector. Lenders are usually ahead of the curve and by watching the big picture we can uncover opportunities that lead us to operational excellence.

Sources: BXMT Investor Presentation, BX website

(An earlier version of this article appeared on the Seeking Alpha website.)