If all you want is income, and many invsestors do, then Arbor Realty Trust (ABR, Financial) may look like a great opportunity at first glance. As of this writing, the company pays out a dividend of $1.60 per share annually and is trading at $10.50 per share, giving it a dividend yield of over 14%. With the stock down nearly 30% since the beginning of March, there could also be a chance for capital gains as well.
As a REIT, Arbor Realty Trust is required to distribute at least 90% of its taxable income to shareholders in the form of dividends. For someone that has assets or a paycheck and doesn’t want to (or is unable to) take on the debt load of owning property, REITs are a solid alternative.
However, a dividend yield and a low price tag don't always make a good investment. Let's take a closer look at the risk-reward situation with Arbor Realty Trust to see whether the stock is a good value or not.
About Arbor Realty Trust
Arbor Realty Trust generates revenue primarily through its financing and investment activities in the real estate sector. The company specializes in investing in a diverse array of structured finance assets within the multi-family, single-family rental and commercial real estate sectors across the United States through two main segments: Structured Business and Agency Business.
A structured portfolio is an investment portfolio that has been strategically designed using a mix of various financial instruments, such as stocks, bonds, derivatives and alternative investments, to achieve specific risk-return objectives. An agency loan portfolio refers to a collection of loans that are either originated, underwritten, or serviced by a financial institution on behalf of GSE’s or other government agencies. By providing loans with higher interest rates and carefully selecting borrowers and projects, the company maximizes its interest income. Over the last decade, Arbor Realty has grown its net interest income from $57 million to $390 million.
Its primary investments include bridge and mezzanine loans, junior participating interests in first mortgages, preferred and direct equity, real estate-related joint ventures, real estate-related notes and various mortgage-related securities. As a loan originator and servicer, Arbor Realty Trust earns fees for underwriting, closing, and servicing loans. This includes loans provided through government-sponsored enterprises (GSEs) like Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA). Loan origination and servicing fees are a significant source of revenue for the company. In the fourth quarter alone, agency loan originations were $1.55 billion with structured loans of $500 million with servicing portfolios of $28 billion and $14.5 billion respectively. In 2022, mortgage banking accounted for $69 million in revenue.
Financial performance
All in all, the company generated $654 million in total revenue in 2022 with $284 million being pushed to the bottom line. It had a total interest expense of $557 million on total interest and dividend income of $948 million.
While standing at an impressive 63%, the operating margin could be even better. Over the last decade, Arbor Realty has kept the cost of services relatively stable around $50 million a year, but salaries and employee benefits have risen 13-fold. As recent as 2016, this number was around 22% of total revenue. In the last 12 months, it was north of 25%, having grown from 14% in 2013, up over 75%. Maybe that’s being a bit nit-picky and this rise is just a product of high-level executives receiving performance-based bonuses, in which some investors might say the expense is justified. However, I personally am not a fan of paying ludicrously high compensation packages to the top brass.
Fortunately, these expenses haven't slowed down the company’s financial prosperity. Last year, it raised the dividend three times, and it is expected to do the same in future years. It also authorized a $50 million share buyback plan, which at the current share price makes perfect sense in my view.
Growth also continued last year with the company's structured portfolio growing 19% thanks to $6.15 billion in new loan originations. Its agency portfolio grew 4% with $4.77 billion in new originations. Arbor Realty Trust has also done a good job of balancing costs related to issuing more equity and debt. In the last year it raised $486 million for growth capital via equity offerings and $438 million in new debt to repay existing debt. Were this balancing act to falter, there could be a real problem for shareholders due to the company's high debt levels.
Total return potential
While the company’s dividend yield is one of the highest in the industry, the potential for capital gains is what makes the stock even more attractive in my view. There may be fears of a recession or worse, a de-dollarization that would collapse the U.S. dollar (which could happen if the U.S. government defaults on its debt), but I personally think a U.S. debt default is unlikely. The government would probably rather issue a trillion-dollar coin and suffer 10%+ inflation than default on its debt.
The real estate and banking industries have suffered from the rising interest rates, but that looks set to end soon given lower inflation numbers and the need to stabilize the debt market. All of the mortgage REITs are down big over the last year and many are looking cheap, though that's another story. Out of the REITs with market capitalizations above $1 billion, Arbor Realty Trust is the only one paying this high of a dividend yield. It’s also down nearly 40%, more than its closest competitors. I think it’s only a matter of time before Mr. Market realizes his mistake on this one.
