Published on July 1st, 2020 by Josh Arnold
In general, income investors tend to focus on a high current yield, a safe dividend with rising payouts over time, or a combination of these qualities, depending upon their specific investment needs and goals.
The problem is that most dividend stocks don’t provide all three, so investors have to make choices about what is more important to them. Real Estate Investment Trusts – or REITs – are often a source of high current yield, safety, and growth for dividend investors.
Broadmark Realty Capital (BRMK) is a REIT with a high current yield of 7.6%, but its dividend safety and growth prospects are both quite poor. On the plus side, Broadmark pays its dividends on a monthly basis, which is rare in a world where the vast majority of dividend stocks make quarterly payouts.
There are currently only 56 stocks with monthly dividend payments. You can download our full list of monthly dividend stocks (along with price-to-earnings ratios, dividend yields, and payout ratios) by clicking on the link below:
Broadmark’s high current yield and monthly payment make it attractive purely from an income perspective, but the future outlook is uncertain. Adding to investor concerns is that the company cut its dividend earlier this year.
This article will analyze the investment prospects of Broadmark Realty in further detail.
Broadmark Realty offers short-term, first deed of trust loans that are secured by real estate. These loans are used by customers to fund the acquisition, renovation, rehabilitation, and development of residential and commercial properties in the US.
The trust was formed in 2010 and has originated more than a thousand loans in the decade since with an aggregate face value of more than $2.4 billion. Broadmark has been public for less than a year, having completed its IPO in November 2019.
Source: Investor presentation, page 2
An interesting fact about Broadmark that is highly unusual for a REIT is that it has no outstanding debt. REITs quite commonly load up on huge amounts of debt to fund portfolio expansion, but Broadmark hasn’t done that. All of its loans are funded from cash on the balance sheet, which is extraordinary.
The advantage of this is that Broadmark has superior lending margins – because it has no interest expense to pay – and it provides an additional margin of safety. Broadmark isn’t subject to margin calls or other covenants from its own creditors because it doesn’t have any.
In addition, Broadmark’s weighted average loan-to-value is just 60%, meaning its loans have a significant margin of safety should payments stop. The trust can take possession of the properties with significant equity built in, and recover its losses for the most part.
Source: Investor presentation, page 3
The trust’s portfolio consists of a decent mix of residential and commercial properties, although Broadmark is still primarily a residential lending story. About 55% of the total portfolio is in residential loans, and about 97% of the total is concentrated in the Pacific Northwest and Mountain West combined.
This lack of diversification, both in geography and loan type, make us cautious on Broadmark’s ability to handle the current recession, and recessions that are to come.
Broadmark has managed to grow its loan portfolio in the past couple of years, driving interest income and fee generation higher. Since the trust has no funding costs, its lending margins are exceptional. That means that when Broadmark grows its lending portfolio, the additional operating income that is derived from the revenue gains is significant.
We see this trait continuing as the trust had more than $250 million of cash on its balance sheet at the end of the first quarter, so it has plenty of capital to continue to boost its lending activity. On the other hand, Broadmark is seeing significant weakness from its lending portfolio thanks to impacts from COVID-19. As of the end of the first quarter, a staggering 14.2% of its portfolio was in default.
The trust’s focus on construction loans means that it is dependent upon its customers completing their projects on time, and subsequently paying Broadmark for the loan. With construction activity slowing or stopping altogether in many parts of the country, Broadmark’s portfolio is suffering.
Broadmark has several ways to resolve defaults, including loan modification to taking possession of the property, but this is a costly activity for the trust to undertake, and will crimp FFO generation.
Source: Investor presentation, page 5
First quarter core earnings came to $0.21 per share, which compares somewhat unfavorably to the $0.24 per share the trust paid in dividends. Broadmark originated 21 new loans in a total of eight states in Q1, with a face value of $107 million, so it continues to boost its portfolio aggressively. The originations had a weighted average LTV of 61.5%, slightly higher than the rest of the portfolio, but still quite strong from Broadmark’s perspective.
Broadmark maintains a positive growth outlook, given its pristine balance sheet. Indeed, it has essentially no limitations on how much it can continue to grow its lending portfolio, particularly if it decides to take on debt to expand the portfolio.
However, we are still wary of its reliance upon two relatively narrow geographical areas, as well as its reliance upon residential construction loans. We believe Broadmark can grow FFO in the mid-single-digits in the coming years, but caution investors that a high number of defaults were present at the end of Q1, and that there is very little history on Broadmark since it has been public for less than a year. This means risks are somewhat higher for Broadmark than some other REITs.
Broadmark’s dividend payment stood at $0.12 per share in December 2019. However, the dividend for January was reduced to $0.08 per share. The April, May, and June distributions were in the amount of $0.06 per share. This demonstrates a concerning trend of multiple dividend reductions in the recent past.
Still, at an annualized payout of $0.72 per share, Broadmark stock has a current yield of 7.6%, which is nearly four times that of the broader market, as measured by the S&P 500. With a high dividend yield, along with monthly payments, Broadmark stock is attractive from an income perspective.
We expect Broadmark to produce between $0.75 and $0.80 in FFO-per-share this year, or “core earnings” as the trust referred to it as in the Q1 release, which means that its dividend coverage is relatively poor. We expect Broadmark to pay out essentially all of its FFO this year, which means that if the downturn in the lending market worsens, the distribution may be at risk of yet another cut.
Broadmark can likely afford the current payout of $0.72 annually due to the high level of cash on its balance sheet, which it can use to fund any deficits between FFO and declared dividends. Of course, this is not sustainable over the long-term. The decline in the share price over the past several weeks is likely an indication that even the current monthly payout of $0.06 per share may not be safe.
This also means that the prospect of dividend growth isn’t particularly strong with Broadmark, as we see the weakness in the trust’s portfolio that was evident in Q1 as being a longer-term problem. Broadmark’s narrow focus means very little diversification. Sustainable dividend growth will likely be an issue for a long time to come.
While Broadmark’s high dividend yield and monthly payment schedule are appealing, investors should be cautious. The extreme level of defaults seen in Q1 likely hasn’t abated yet given the high concentration in terms of geographic and loan type. The dividend payout is at risk due to this.
In addition, the trust is trading at 118% of end of Q1 tangible book value, so the stock is slightly overvalued as well. Given these factors, we do not see Broadmark as a safe dividend stock, and would recommend investors pass on it until the prospects for its portfolio improve.
With wide-scale shutdowns across the country due to COVID-19, the construction loans made by Broadmark are at greater risk than those financed by cash flows. Broadmark’s inherent risk is much higher than other REITs.