Seven Hills Realty Trust

Good morning and welcome to Seven Hills Realty Trust's second quarter 2024 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Stephen Colbert, Director of Investor Relations. Please go ahead.

Good morning. Joining me on today's call are Tom Lorenzini, President and Chief Investment Officer, Fernando Diaz, Chief Financial Officer and Treasurer, and Jared Lewis, Vice President. Today's call includes the presentation by management, followed by a question and answer session with analysts. Please note that the recording, retransmission, and transcription of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on Seven Hills' beliefs and expectations as of today, July 30, 2024, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, We will be discussing non-GAAP financial numbers during this call, including distributable earnings and distributable earnings per share. A reconciliation of GAAP to non-GAAP financial measures can be found in our earnings release presentation, which can be found on our website at scvnreit.com. And with that, I will turn the call over to Tom.

Thanks, Steven. Good morning, everyone. Thank you for joining our call today. As Steven mentioned, Jared Lewis has joined our team at Seven Hills Realty Trust as vice president. Jared and I have worked together for over 20 years at Tremont Realty Capital, our manager, where he leads the underwriting team responsible for screening and structuring new investments. We look forward to Jared's continued contributions to our ongoing success at Seven Hills. Last evening, We reported strong second quarter results highlighted by distributable earnings per share that were above analyst consensus estimates. The continued strength and stability of Seven Hills Investment Portfolio is a reflection of our resilient loan book supported by our disciplined underwriting, originations, and asset management teams. With ample liquidity on hand and a robust pipeline of new opportunities under evaluation, we look forward to building on our momentum as we move into the second half of 2024. Turning to a few highlights from the second quarter, we delivered distributable earnings per share of $0.38, exceeding our $0.35 per share quarterly dividend by 9%. The credit profile of our loan portfolio remains stable with an overall average risk rating of 3, with no loans in default and no non-accrual loans. We received one loan payoff for $17.3 million and we accelerated our loan production, closing $41.6 million across two new loan commitments. From a macro perspective, while the U.S. economy has remained resilient with relatively strong economic activity, inflation readings have begun to recede to what the Federal Reserve has indicated is within their comfort level. As a result, the market now expects to see interest rate reductions beginning later this year. An easing rate environment traditionally bodes well for commercial real estate transactions, and we continue to believe that lower interest rates will lead to increased lending opportunities in the months ahead. Turning to our second quarter portfolio activity. A conservatively underwritten portfolio continues to experience repayments across various property types. During the quarter, we received the repayment of our Scottsdale hotel loan totaling $17.3 million. And earlier this month, we received a $19.7 million payoff on a Portland multifamily property. We closed on two new loans during the second quarter as transaction activity increased. A $17.8 million loan on the acquisition of a multifamily property in Virginia and a $23.8 million loan on a self-storage facility in Los Angeles. From a capital perspective, Our securities financing partners remain very supportive of our business and continue to provide us ample capacity to originate new loans. Turning to our loan book, as of June 30th, Seven Hills Portfolio remained 100% invested in floating rate loans, which consisted of 22 first mortgages with an average loan size of $30 million and total commitments of $652 million. With our two recent investments, our portfolio increased approximately 4% or $23 million sequentially, while future fundings remain consistent at only about 6% of total commitments. Our investments have a weighted average coupon of 9.1% and an all-in yield of 9.6%. In aggregate, the portfolio has a weighted average maximum maturity of 2.6 years when including extension options and a stable credit profile with an average risk rating of 3 and a loan-to-value at close of 68%. None of our loans are rated 5. We continue to make progress diversifying our loan book. As of quarter end, multifamily was our largest property type at 37%, while we have decreased our office exposure to 27%, and the balance of our portfolio is comprised of retail, hospitality, self-storage, and industrial loans. In terms of portfolio vintage, as a reminder, Seven Hills portfolio now consists entirely of loans that were originated subsequent to the onset of the pandemic. We recently agreed to extension terms with our Dallas borrower whose outstanding loan of $43.5 million was set to mature in August. The borrower continues to support the asset and will be contributing additional capital to be invested into the property. And in return, we will be providing additional term allowing the borrower to complete their business plan. Our 26.6 million Plano, Texas loan, which was set to mature on July 1, has been extended on a short-term basis while we finalize the documentation for a longer 24-month term extension. This asset is outpacing the market with current occupancy at 88%. Turning to our active deal pipeline, we continue to see a steady flow of potential deals in our pipeline with over $700 million of prospective lending opportunities in various stages of our screening, diligence, process consisting of acquisitions and refinancing requests for industrial, multifamily, self-storage, retail, and hospitality properties. We remain on track to deliver on our goal of six new loans in 2024 with one loan currently in diligence and several additional term sheets outstanding. In closing, our portfolio and overall credit performance remains strong and our business continues to deliver solid results. With the Federal Reserve expected to cut interest rates potentially as early as their next meeting in September, we believe we are well positioned to accelerate loan production in the back half of this year and for our portfolio to deliver attractive returns for our shareholders. And with that, I'll now turn the call over to Fernando.

Thank you, Tom. And good morning. Yesterday afternoon, we reported second quarter 2024 distributable earnings, or DE, of $5.6 million, or 38 cents per share, which was one cent above the high end of our guidance range, primarily due to the early repayment of our hotel loan in Scottsdale, Arizona. In mid-July, we declare our regular quarterly dividend to shareholders of $0.35 per share, payable on August 15th, which our second quarter DE covered by approximately 109%. On an annualized basis, our dividend equates to a yield of approximately 10.5% based on yesterday's closing stock price. Our seasonal reserve remains modest at 120 basis points of our total loan commitments as of June 30th, compared to 100 basis points as of March 31st. While this metric increased slightly, all loans remain current under debt service and we have no non-approval loans. As a reminder, to help protect us against investment losses, we structure all of our loans with risk mitigation mechanisms such as cash flow sweeps, interest reserves, and rebalancing requirements, and we do not have any collateral dependent loans or loans with specific reserves. In the second quarter, Seven Hills maintained its conservative leverage metrics and continues to have substantial liquidity. We ended the quarter with over $345 million of liquidity consisting of $69 million of cash on hand and $276 million of borrowing capacity. And we had a weighted average borrowing rate of sulfur plus 216 basis points at the end of the quarter. Oil debt to equity increased from 1.5 times to 1.6 times at the end of the previous quarter, primarily due to the loan repayment that Tom discussed. We believe that our conservative leverage and available borrowing capacity provide a strong opportunity to originate accretive loans that will benefit the company going forward. Turning to our outlook and guidance for the third quarter, we expect distributable earnings to be flat sequentially at $0.35 when excluding the $0.03 of repayment income that we saw in the second quarter. This guidance reflects our expected originations and repayment activity and assumes flat G&A expenses and that interest rates will remain consistent with current levels. That concludes our prepared remarks, and with that, operator, please open the lines for questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question today is from Jason Weaver with Jones Trading. Please go ahead.

Hi, good morning. Thanks for taking my question. I was hoping you could address a little bit more about the origination environment, specifically how it pertains to the level of competition within the marketplace, and that's specifically within your buy box, if that is, you know, the amount of capital coming in is in any way crowding out the opportunity set for yourself.

Sure, Jason. I would tell you that the market is competitive. And one of the reasons it's competitive is because there's certainly a dearth of new transactions, sales transactions happening in the marketplace. So we're seeing more refinance opportunities. And ultimately what happens on a lot of these transactions is that they may not end up happening, right? Borrowers may simply be kind of shopping around a little bit to see if they can get a better deal than their current lender, and ultimately they don't transact and they stick with their current lender. When we do find transactions that work, especially if it's an acquisition and has decent cash flow and a solid debt yield and is of the quality sponsorship-wise and real estate-wise that we want, we find that to be a very competitively bid situation. because there is ample liquidity on the sidelines with various debt funds, even with the, we're starting to see the other commercial mortgage REITs start up originations again. So those transactions that work are very competitively bid. You know, we would anticipate and it's our hope that in the back half of the year, if we start to see some rate relief, that that will cause more transactions to trade, i.e. more sales, and then there'll be more opportunities for lenders such as us, but also there'll be a bigger pool of transactions to bid on. Because right now, when you find one that works, we generally find ourselves competing against five or six or maybe even 10 different lenders.

Oh, great. Thanks for that color. And along those same lines, I wonder if your estimate of activity picking up in the back half of this year has moved marginally in line with the last six weeks. We've seen a number of softer economic figures that indicate there might be some more monetary easing ahead. Have you grown in confidence in that view?

Yeah, I think so. You also need to look back kind of at the beginning of the year or at the end of last year when people were expecting four to six rate cuts in 2024. We saw an uptick in volume coming into our pipeline. And then as the Fed backed off of that and the market backed off and said, oh, we're not going to have nearly that level of interest rate cuts, we might not have any, then we saw volume drop off. Now we're starting to go again the other way where we're starting to see volume pick up because I think sponsors are, you know, they're optimists and if they believe that the Fed is going to be on a rate cutting path over the next several quarters, they want to get ahead of that and start thinking about financing, start thinking about selling and seeing if they can better their lie, if you will, with their cost of capital. As the Fed begins to cut, I think you're going to see optimism come in from the real estate investors, and you'll see, again, we'll start to see more transactions happen.

All right. Thanks again, guys, and congratulations on the quarter.

Thank you. Again, if you have a question, please press star, then 1. The next question is from Chris Muller with Citizens JMP. Please go ahead.

Hey, everyone. Thanks for taking the question. So kind of following up on that last theme, you guys are one of the only commercial mortgage rates that's actively lending. Some of the other guys are starting to pick up, and maybe we see a little bit of that as everyone reports. But I guess, how are you guys thinking about portfolio growth over the coming quarters? And is this pace of origination a good ballpark, or do you think that'll start to pick up as that pipeline starts to fill out a little more? Thanks.

Well, again, as I mentioned in the prepared remarks, Chris, we're anticipating six transactions in 2024. Six to eight, I would say. We've already closed two this year. We have one that's in diligence, and we do have a pretty solid pipeline. Our goal would be really, from a production standpoint, I think we're probably looking at $200 million of total production or so for 2024, and we think that that's achievable, obviously most of which is going to happen in Q3 and Q4. Got it.

That's helpful. And then I guess with the rent concessions on the Yardley office now expired, is a sale in 2024 a possibility, and have you guys started marketing that property yet?

We have not started marketing that property. I think we've been planning to hold that through 2024. I think in the environment that you're in today, to put an office building on the marketplace, a performing office building that has cash flow, I don't know that you'll get quite the attention you would get until that market begins to stabilize a little bit more. That is adding a couple cents to DE. The property is well leased. They continue to renew tenants there. They continue to have tours for the vacant space there. I think we're 81% or so occupied there. So really, the property is performing well. It fits well within our portfolio. RMR, as you know, manages that asset. So really, it's just kind of status quo at the moment. We'll make that decision with the board. you know, probably going into 2025 to determine what we want to do there.

Got it. Thanks for taking the questions.

Sure. Thank you, Chris.

The next question is from Jason Stewart with Channy. Please go ahead.

Hey, thanks for taking the question. Fernando, I missed the guidance. If you could just repeat that for me, I'd appreciate that. Thank you.

Sure, yeah, we're guiding $0.35, which excludes $0.03 of prepayment income that we saw in the second quarter from our prepayment of one of our hotel loans, so $0.35 for the next quarter.

Okay, and obviously that includes the yardly contribution, right? Obviously I should.

That is correct, exactly, yeah. $0.02 that we get from, yeah.

Okay, I got it. That was it for me.

Thanks a lot. Thanks. This concludes our question and answer session. I would like to turn the conference back over to Tom Lorenzini for any closing remarks.

Thanks, Gary. Thanks, everyone, for joining us today. We look forward to seeing you at the Janie Financial Services Conference in Washington, D.C. in September.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.