Dazed and confused

Lacking earnings to support its ambitious scope of real estate activity, RAIT financial trust is relying on capital markets

June 30, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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RAIT Financial Trust (RAIT) is a real estate investment company. It owns over $2.3 billion in U.S. commercial real estate properties. But the company is a lender too. Its commercial real estate, mezzanine, preferred equity loans exceed $1.6 billion dollar. The company also manages two billion in real estate assets where it earns a property management fee. Unfortunate to its investors, RAIT ambitious operational scope has yet to translate to earnings.  

Revenue increased in past three years by 12 percent. The company earned $324 million in 2015 compared to $247 million in 2013. The revenue composition is attributed to rental income (50 percent), interest income (30 percent), and the remaining income is fee-related. But the increase in revenue was artificial. 

Debt obligations mushroomed by 66 percent. In 2014, RAIT carried $532 million of recourse debt obligations and $2.1 billion of nonrecourse loans for a total indebtedness of $2.6 billion. In 2015, it added both nonrecourse and rocourse loans for a total indebtedness of $3.4 billion.

Increase in operating expenses followed. Compared to 2014, operating expenses increased by 40 percent. Notably, interest expense increased to $84.3 million, from $55.4 million. And real estate operating expense increased to $109 million from $81.6 million the year prior. 

RAIT financial trust income statement
Source: Company 10-k filings

Net earnings are in the red. Between 2013 and 2015, the company generated a revenue of $860 million, operating expense was $770 million and non-operating expense was $514 million. This non-operating expense is related to change in fair value of its derivatives position. Specifically, CDO notes payable and trust preferred obligation market value. Between 2013 and 2015, the company exhibited a net loss of $424 million.

But against conventional wisdom, RAIT appetite, to acquire assets, remains. Compared to 2014, its real estate portfolio increased by $895 million, a 30 percent increase. Its real estate under management increased by $645 million, an increase of 50 percent. And its commercial real estate loan portfolio increased by $293 million, an increase of 25 percent. 

Three reasons may explain this irrational corporate behavior. First, borrowing in a pygmy interest rate environment may have enticed the company to purchase real estate. Second, the company blindly followed a frenzy expectation from shareholders to increase both revenue and Funds from operations. And mild success was achieved as three of the six analysts researching the company are positive about its future, note Marcus Daley and Heather Anthony of Franklin Independent News Corp, a media company. Third, acting as a lender, an investor, and a manager would confuse anyone. It may be time for RAIT Financial to scale down.

RAIT financial trust balance sheet
Source: Company 10-k filings