Bank of America downgraded six companies in the commercial real estate (CRE) mortgage REIT sector, saying it sees a “challenging road ahead” for the industry due to interest rate headwinds and weakening fundamentals.
Bank of America research analyst Eric Dray, CFA, said in a client note on Monday that the sector's book values could trend downward over the coming quarters, dampening investor sentiment.
According to Bank of America, “the U.S. office sector faces headwinds from a delayed return to the office,” as evidenced by weak real rent growth of just 0.5% year-over-year in the fourth quarter of 2023 and a rise in vacancy rates to 19.6%.
Bank of America downgrade
Several mREITs were downgraded by BofA, reflecting the outlook for continued sector pressure.
Ares Commercial Real Estate Corporation (NYSE:ACRE): Downgraded to Underperform, new price target (PO) lowered to $7 from $11. Notable concerns include heavy investments in office and approaching portfolio maturities, recent credit issues and dividend cuts. Apollo Commercial Real Estate Finance (NYSE:ARI): Downgraded to Underperform, PO $10.50. The company indicated further dividend cuts are possible due to approaching high-profile maturities and narrow dividend coverage. Brightspire Capital (NYSE:BRSP): Downgraded to Underperform, PO $6.50. Despite recent improvement in portfolio credit quality, investments in pressured sectors such as U.S. office and Sunbelt apartment complexes are the driving factors. TPG RE Finance Trust (NYSE:TRTX): Downgraded to Underperform, PO raised to $6.50 from $6.00. Significant portfolio shrinkage and unresolved credit issues raise concerns about future dividend sustainability. Starwood Property Trust (NYSE:STWD): Downgraded to Neutral from Buy. PO cut to $21.50 from $22.50. Diversified portfolio with limited exposure to office is a positive, but visibility into upcoming maturities is unclear. Blackstone Mortgage Trust (NYSE:BXMT): Downgraded to Neutral from Buy. PO cut to $21 from $22. On the positive side, borrowers and sponsors continue to invest in real estate, but growing office exposure, high leverage and sizable near-term maturities are major concerns.
Future risks
“CRE fundamentals remain shaky and we expect CRE mREIT portfolios to face increasing pressure as interest rates remain elevated for an extended period of time,” Dray emphasized.
Analysts stressed that variable rates are the norm for CRE loans, as rising rates could threaten property values and the ability to refinance, leading to increased defaults and forced capital injections by borrowers.
Despite the current discount to CRE mREIT stocks, Bank of America's analysis suggests risks are tilted toward further downside. Weaker fundamentals in the office sector, combined with high leverage levels among mREITs, could amplify the impact of bad loans and drive book values down further.
Market reaction
Ares Commercial Real Estate shares fell 3.2% on Monday, extending their year-to-date decline to 28%. Apollo Commercial Real Estate Finance shares fell more than 4% to $10.29. Brightspire Capital shares fell more than 5% and are on track for their worst closing since early August 2023. Starwood Property Trust and TPG ReFinance Trust both fell 2%. Blackstone Mortgage Trust shares fell nearly 3%.
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