KKR Real Estate Finance: CRE Anxiety Will Last Through 2024

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KKR Real Estate Finance (NYSE:KREF) has been forced to cut its quarterly dividend. The commercial real estate lender declared a $0.25 per share quarterly distribution, a 42% dip sequentially, and $1 per share annualized for a roughly 10% forward dividend yield. When I last covered the mortgage REIT, I highlighted insufficient dividend coverage of just 58% against its prior third-quarter distributable earnings. This prior setup embedded book value erosion, so a dividend cut was not only necessary but prudent, and comes against renewed regional banking angst on concerns over CRE exposure that’s reminiscent of the same period a year ago when several banks folded.
KKR Real Estate Finance Fiscal 2023 Fourth Quarter Supplemental
What’s next for KREF after the cut? Likely more uncertainty on the back of its office property exposure as this asset class becomes the villain for a REIT stock sentiment looking to the Fed to define its near-term future. The commons fell 14% intraday on the mREIT’s fourth-quarter earnings release that showed revenue dipped by 10% year-over-year to $50.67 million. KREF also realized a $58.7 million loss, around $0.85 per share, on a defaulted senior office loan. Negative sentiment has also fed through to the preferreds (NYSE:KREF.PR.A) despite the dividend cut being a good thing from an asset coverage perspective. Both securities stand to possibly see more market anxiety on continued market angst around CRE and expectations of more office loan defaults.
Credit Quality, Originations, And Book Value
KKR Real Estate Finance Fiscal 2023 Fourth Quarter Supplemental
KREF’s loan portfolio at the end of the fourth quarter was $7.75 billion, dipping by $118 million sequentially on the back of repayments running ahead of originations and the write-off associated with the Philadelphia senior office loan. The mREIT’s portfolio has been retrenching sequentially since the start of its fiscal 2023 with KREF taking a prudent stance by allowing repayments to run close to or ahead of originations against a disruptive macro backdrop. The mREIT’s book value at the end of the fourth quarter was $1.08 billion, around $15.52 per share, and down 77 cents sequentially from $16.29 per share at the end of the third quarter. This was also down from $18 per share at the start of fiscal 2023. Hence, it’s now critical that KREF take steps to reduce book value erosion, and the dividend cut should contribute towards this objective.
KKR Real Estate Finance Fiscal 2023 Fourth Quarter Supplemental
KREF’s office property exposure is where the market angst lies, however, this forms 23% of its loan portfolio. Not insignificant, but it’s not at a level that will demand a forever discounting of commons, currently trading 36% below book value per share. The market is forward-looking and pricing in a continued dip of book value, but this will be true until it isn’t with the rightsized dividend set to save 18 cents per share of book value sequentially, around $0.72 per share annualized. Around 84% of KREF’s loans are still with a risk rating of 3, a small improvement from 83% in the third quarter. All other risk rating distributions broadly stayed the same apart from loans rated 4 which dipped by 200 basis points sequentially.
KKR Real Estate Finance Fiscal 2023 Fourth Quarter Supplemental
There are roughly three loans with a risk rating of 5 with a default on the Philly office loans seeing KREF take possession of the collateral. However, a Seattle Life Science office building was downgraded from 3 to 5. Critically, whilst the default on the Philly office loans which still had $149.8 million of outstanding principal left is not great, it’s 1.9% of the mREIT’s loan portfolio with the market response seemingly outsized but admittedly forward-looking. There is another $512 million in outstanding principal across watch list loans with a 5 risk rating, which had an average max remaining term of 2.3 years.
KKR Real Estate Finance Fiscal 2023 Fourth Quarter Supplemental
Liquidity And The Fed
Critically, KREF and REITs will remain in the doldrums absent any interest rate cuts from the Fed. It’s an odd sensation to see the market making new highs almost daily as income plays get driven to new 52-week lows, but higher for longer will see sentiment kept low and the current discount to book value will remain sticky.
KKR Real Estate Finance Fiscal 2023 Fourth Quarter Supplemental
KREF reported a net loss attributable to common stockholders of $18.7 million during the fourth quarter, around $0.27 per share. This drove negative distributable earnings of $26 million, around $0.37 per share. The mREIT has enough liquidity to maintain its current $17 million per quarter commons distribution with distributable earnings prior to the realized loss from the Philly office loan of $0.47 per share proving enough coverage for the rightsized dividend. I don’t own a position in the commons though, but 2024 could open up some opportunities if KREF’s book value is stabilized.