Seven Hills Realty Trust quarterly report, Q2 FY2023

Seven Hills Realty Trust 10-Q Summary

Business Context and Reporting Period

Seven Hills Realty Trust is a Maryland REIT focused on floating-rate first mortgage loans secured by middle-market and transitional commercial real estate. This Form 10-Q covers the three and six months ended June 30, 2023; financial statements are unaudited. The company had 24 loans with a $634.9 million principal balance and $625.3 million carrying value at quarter-end.

Key Financial Metrics

Metric	Q2 2023	Q2 2022	Six Months 2023	Six Months 2022
Total revenue	$9.1 million	$7.5 million	$18.4 million	$21.3 million
Net income	$4.6 million	$4.6 million	$12.4 million	$15.7 million
Net income per share	$0.32	$0.31	$0.85	$1.08
Distributable earnings	$5.4 million	Not provided	$11.1 million	$8.8 million
Adjusted distributable earnings	$5.5 million	Not provided	$11.2 million	$8.8 million
Adjusted distributable earnings per share	$0.37	Not provided	$0.77	$0.61

Q2 net profit margin was approximately 51.1%, compared with approximately 61.1% in Q2 2022. The six-month net profit margin was approximately 67.5%, compared with approximately 73.8% in the prior-year period.

Interest and related income increased 78.2% in Q2 and 71.7% for the six months, primarily reflecting higher benchmark rates and newer loan originations.
Net income from loan investments declined 14.0% for the six months because higher interest expense and lower purchase discount accretion more than offset the increase in interest income.
Cash, cash equivalents and restricted cash totaled $82.0 million at June 30, 2023, compared with $48.4 million at June 30, 2022 and $71.1 million at December 31, 2022.
Operating cash flow was $11.6 million for the six months, compared with $6.3 million in the prior-year period.
Investing activities provided $29.2 million, primarily due to $69.5 million of loan repayments, partly offset by $37.0 million of originations and $3.8 million of additional funding.
Financing activities used $29.8 million, including $47.3 million of debt repayments and $10.3 million of shareholder distributions.

Balance Sheet, Debt and Liquidity

Total assets were $727.9 million and shareholders’ equity was $267.8 million at June 30, 2023, compared with $746.8 million and $271.6 million, respectively, at December 31, 2022.
Secured financing facilities had a $454.5 million principal balance, $452.7 million carrying value and a 7.19% weighted average coupon rate. The balance declined from $473.6 million at December 31, 2022, while the weighted average rate increased from 6.34%.
Total secured financing capacity was $682.0 million, with $227.5 million of unused capacity.
Debt maturities included $87.2 million in 2023, $228.8 million in 2024 and $138.4 million in 2025. Management stated that the company was in compliance with all debt covenants at June 30, 2023.
In July 2023, the UBS facility was amended and its stated maturity was extended to February 18, 2025.
Management believes available cash, operating cash flows and unused borrowing capacity will be sufficient to meet operating needs, debt obligations, loan funding commitments and expected distributions for the next 12 months.

Material Changes Versus Prior Periods

The company adopted CECL on January 1, 2023, recording a $6.6 million cumulative reduction to net income and establishing $6.6 million of allowances for loan balances and unfunded commitments.
At June 30, 2023, the allowance for credit losses totaled $5.9 million, including $4.2 million for loans and $1.7 million for unfunded commitments.
The loan portfolio contracted from 27 loans and $669.9 million of carrying value at year-end 2022 to 24 loans and $625.3 million at June 30, 2023. The weighted average coupon increased to 9.01% from 8.07%, and all-in yield increased to 9.47% from 8.57%.
In June 2023, an office borrower in Yardley, Pennsylvania defaulted on May debt-service obligations. The company obtained the property through a deed in lieu of foreclosure, recognized $15.6 million of real estate owned and recorded a $708,000 write-off related to the loan, partly offset by a $627,000 recovery of previously recorded credit loss reserves.
Revenue and expenses from real estate owned were $149,000 and $218,000, respectively, in Q2 and the six-month period.
Q2 net income declined 40.5% from Q1 2023, primarily due to a $1.0 million credit-loss provision, higher general and administrative expense, incentive fees and real estate-owned expenses.
Regular distributions totaled $0.70 per share for the first six months. A $0.35 per-share distribution was declared in July 2023 for payment in August.

Outlook, Commentary, Risks and Unusual Items

The filing provides no formal earnings or investment-volume guidance. Management believes alternative lenders may benefit from reduced bank lending, tighter underwriting standards and opportunities in multifamily and industrial real estate. Management also expects market uncertainty and volatility to continue affecting CRE lending activity.

Higher interest rates increase income on the company’s floating-rate loans but also increase borrowing costs and may impair borrowers’ debt-service capacity.
Office and certain retail assets remain exposed to reduced demand, weaker valuations and refinancing difficulty. Two loans, representing approximately 12% of the loan portfolio, carried a risk rating of 4, described as higher risk.
The weighted average loan risk rating increased to 3.0 from 2.9 at year-end 2022. No loans were past due or on nonaccrual status at June 30, 2023, and management stated that borrowers with outstanding loans had paid amounts owed as of July 27, 2023.
The portfolio had $42.9 million of unfunded loan commitments, and the company had estimated unspent lease-related costs of $726,000.
Borrowers may face increased costs for interest-rate caps or swaps, weaker property cash flows, delayed business plans and refinancing challenges.
The company has no employees and relies on Tremont Realty Capital LLC and affiliated entities for management and shared services, creating related-party and potential conflict-of-interest risks.

Investor Verification Checklist

Verify the valuation, leasing status, operating performance and planned disposition timing of the Yardley, Pennsylvania real estate-owned asset.
Monitor the $5.9 million CECL allowance, changes in CRE pricing forecasts and migration of loans into higher-risk ratings.
Review refinancing and repayment plans for the $87.2 million of 2023 debt maturities and $228.8 million due in 2024.
Assess the effect of SOFR and future rate changes on loan income, borrowing costs, borrower defaults and interest-rate-cap requirements.
Evaluate office-property concentration, borrower refinancing capacity and the $42.9 million of unfunded commitments.
Confirm the sustainability of the $0.35 per-share quarterly distribution relative to distributable earnings and cash flows.
Review related-party management fees, incentive fees, shared-service reimbursements and the July 2023 property-management agreement with RMR.