Co-produced with Treading Softly
During the COVID-19 related shutdowns, mortgage rates plummeted as banks were trying to drive more activity to keep money moving.
Rates have remained stubbornly low, which has prompted more investment and interest in real estate. We’ve spilled much digital ink highlighting how property REITs and mortgage REITs are in a perfect place for your investment dollars right now. As always, carefully thought-out investing is the best course of action. You must determine which options are the right ones and not blindly throw your dollars into the grinder.
Let’s Talk about Hard Money
Sachem Capital (SACH) is a niche lender. It focuses on loans tied to real estate that are shorter than traditional mortgages (only 1-3 years in length). This removes large lenders or banks from competing with them.
Source: SACH Presentation Aug 2020
SACH’s portfolio contains a majority of residential mortgages. These provide the bulk of their income. Furthermore, SACH’s portfolio has grown steadily until early 2020. These residential mortgages are predominantly “fix and flip” loans to small companies that buy beaten-down houses and quickly repair and upgrade them to resell. This has been an extremely popular phenomenon throughout the US.
When COVID-19 hit, SACH took multiple preventative measures to ensure weathering the storm effectively.
For starters, they lowered their allowed Loan to Value ratio to 50%. This means they would not lend any more than 50% of the property’s value to a borrower. This limitation has since been restored back to the previous 70% LTV.
Second, SACH only lent out the money that had come back in. This allowed SACH to keep a large healthy level of cash on their balance sheet should the worst occur.
As of July 1, SACH had relaxed their COVID-19 restrictions and got back into growth mode. This will reflect in strengthening earnings that we have been expecting. Avid High Dividend Opportunities readers will remember prior to COVID-19 we highlighted that SACH’s earnings had been muted by the influx of cash from issuing out additional common equity and two baby bonds. That cash had never gotten off its feet before Connecticut was hit by COVID-19 related shutdowns.
Source: Google Search
Connecticut has weathered the worst of COVID-19 it seems and the state has largely reopened. Management of SACH sees business resuming to normal or higher than normal activity as real estate sales remain bustling. Sales in much of CT have jumped 13% year over year. This is significant in a state where new home building opportunities remain low. The low new-builds in CT again make it an excellent place to be a house flipper. Cheap loans for new buyers and a red-hot market means flippers will not be holding houses for long. This is good and bad for SACH. They will not get as much interest but they’ll get to reap all those origination fees.
SACH is headquartered in Connecticut and the vast majority of its lending activity is concentrated there. Future growth is looking towards Florida’s and Texas’ busy real estate markets, but as per usual with SACH, they are being extremely conservative about their actions.
Not Your Usual mREIT
Mortgage REITs (aka mREITs) got slammed during the beginning of the COVID-19 related market drop. This was largely due to margin calls from lenders forcing poorly-timed forced selling to meet those calls. This only occurred because those mREITs used their own loan portfolio as collateral to receive money to buy more loans. In a stable market, this works extremely well to juice returns. It’s a higher-risk, higher-reward strategy.
It’s one that SACH’s management refuses to consider. They have repeatedly said they will not lend out their “paper” or loans in their portfolio. SACH actually paid off its revolver to free itself from the restrictions placed on it by the lender. This meant that as the market fell in a panic and other mREITs were forced to hemorrhage their book value and loans, SACH was completely untouched. SACH common was sold off like the rest of the sector, but their earnings power was completely unaffected. SACH’s leverage profile is attractive and significantly less complex than others.
SACH’s only debt is their three publicly-traded baby bonds. These bonds provide SACH cheaper debt to grow vs issuing common shares and have been extremely popular with HDO members for their steady reliable income. They are:
- Sachem Capital Corp., 7.125% Notes due 6/30/2024 (SCCB) – Yield 7.0%
- Sachem Capital Corp., 6.875% Notes due 12/30/2024 (SACC) – Yield 6.9%
- Sachem Capital Corp. 7.75% Notes due 9/30/2025 (SCCC): This baby bond just began trading September 10th just above par, which yields 7.7%.
These are three ways to capitalize on a strong real estate market and low rates. SACH earns on average a rate of 12.38% on its loans, excluding origination fees received. This leaves plenty of room with these baby bonds for their interest payments to be strongly covered and additional money to pay common shareholders and grow further.
Due to there being no other debt in the pile, in the extremely unlikely event of SACH collapsing, holders of these baby bonds have equal rights to recovery before common shareholders. The bonds have a coverage ratio of 254% or (2.54 times) leaving a large safety cushion for recovery. Overall SACH can be considered having a low level of leverage.
For those investors looking for stable income, buying whichever baby bond yields the highest at the time is the best course of action.
What About the Common Shares?
If you’re looking for a way to get income AND capital appreciation, SACH common shares are the way to go. While you would not go wrong hoarding as much of the baby bonds offered as possible, their common shares also offer tremendous value.
At the six-month point in 2020, SACH already has produced more than 50% of its net income it produced last year:
Its per-share earnings however are lower due to the higher increased share count. With SACH opening the door for additional lending from their idle cash, we expect their earnings to continue to ramp higher. SACH had $20.6 million in cash on hand as of June 30. SACH also just issued their latest baby bond and received another $12.3 million in cash. With an average yield of 12.38%, these funds could generate an additional $4,073,020 in annual revenue – an additional $3,065,980 after the new baby bond interest is deducted. This equates to an additional $0.138 per share annually. SACH has room to see its revenue grow strongly. SACH is attractively priced considering how low-risk their capital structure is.
SACH’s management has long been committed to their dividend. During the COVID-19 shutdowns, SACH’s management suspended the dividend to keep as much cash on hand as possible. Since then, they have resumed their normal quarterly payment level. SACH’s management already has indicated that they will pay out close to 100% of their taxable income as is normal for them to do.
With this $0.12 a share quarterly payout, SACH yields almost 12% at current prices. This leaves room to lock in a high-income opportunity that also has room to rapidly rise closer to its book value.
Conclusion: 4 Ways to Play for Income
Residential real estate is currently in very high demand. Investing in this sector is an extremely popular and effective way to hedge against inflation and produce steady income. Investing in SACH is a great way to benefit from this recovery. SACH’s process of lending to fix-and-flip style companies allows you to benefit from the current real estate boom going on in Connecticut and around the US due to low mortgage rates. The company has top-notch management with lower leverage which reduces the risk.
SACH offers four compelling ways for an income investor to benefit from their firm.
The first three are buying and holding their various baby bonds. These bonds have a high level of coverage and provide steady stable income until 2024 or 2025. The two older baby bonds SCCB and SACC yield around 7%. On the other hand SCCC started to trade last week at prices that yield 7.7%. All three baby bonds are shorter term and offer a good way to place your money, but SCCC is a great opportunity because it’s brand new and is still “under the radar for most investors.” The baby bonds are more suitable for conservative investors who are looking for income with lower price volatility.
The fourth way to play is buying their common shares yielding 12% – they are worth a close look. Their discount to book value will not last long. SACH common shares are a strong buy at the current price.
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Disclosure: I am/we are long SACH, SCCB, SCCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities.