Commercial loans for the acquisition and refinancing of apartment buildings appear to be on the upswing.
Illustration by Andrea Ucini
Trends in the residential mortgage market look troubling. Rising interest rates are stoking fears that lending activity will slow, hitting the refinancing business particularly hard. Rocket Companies (ticker: RKT), a residential lender, has become a battleground stock between the mortgage bulls and bears.
Yet another side of the mortgage market—commercial loans for the acquisition and refinancing of apartment buildings—appears to be on the upswing. Even as higher interest rates remain a worry, investment in multifamily buildings has been growing, fueled by demand from private pools of capital and ample funding from the U.S. mortgage agencies, Fannie Mae and Freddie Mac.
A rising star in financing the multifamily market is Walker & Dunlop (WD). Its revenue rose 33% last year, to $1.1 billion, from 2019, while net income surged 42%, to $246 million. Wall Street expects earnings to rise 13% this year. Longer term, the company seeks to nearly double earnings per share by 2025. If it can deliver, the stock should be a winner.
“We have a lot of growth initiatives,” says CEO Willy Walker, whose grandfather co-founded the company during the Great Depression. When Walker took over from his father in 2007, the firm was privately held, had about 100 employees, and was worth $25 million. Today, it has more than 1,000 employees, $4.7 billion in assets, and a $3.2 billion market cap. Revenue grew at an 18% annualized rate since 2015.
Walker & Dunlop (WD)
Commercial Mortgage Lender
E=Estimate
Source: FactSet
Along with JPMorgan Chase (JPM), Wells Fargo (WFC), CBRE Group (CBRE), and Berkadia, W&D is among the top five in multifamily loans, financing $24 billion worth last year. And at 12 times 2021 earnings, W&D stock is cheaper than its bigger rivals. JPMorgan and Wells Fargo trade around 15 times, while CBRE goes for 20 times 2021 earnings.
“They trade at a discount for a company growing at a 15% clip, and they’re small enough that it’s easier for them to grow than a big commercial lender,” says Bill Hench, manager of the Royce Opportunity fund. He sees the stock hitting $150 in the next few years, fueled by earnings growth, while its multiple holds steady.
W&D makes money by originating loans that are largely funded by Fannie and Freddie. It earns fees and a profit margin on the interest rate, and sells the loans to the mortgage agencies or private investors, keeping its balance sheet light. Revenue also comes in from brokering sales, structured finance, and servicing rights on loans. W&D’s servicing asset base reached $107 billion last year, up 15% over 2019, with servicing fees amounting to 22% of total revenue.
Servicing—processing loan payments and handling administrative tasks—generates steady cash flows and a pipeline for new loans, which tend to mature every 10 years. “We get to take another bite of the apple since we know who the borrower is,” Walker says. W&D also aims to capitalize off brokerage sales and structuring new debt deals as loans mature.
Wedbush Securities analyst Henry Coffey calls W&D a “money-making machine with a lot of arrows in its quiver.”
The company now wants to become the largest multifamily lender and broker. W&D has outlined a goal of nearly tripling annual loan volume to $60 billion and quadrupling brokerage volume to $25 billion by 2025. It is targeting growth markets like Houston, Denver, and Phoenix.
The firm’s average loan size is about $20 million, but it is aiming to capture more loans of about $5 million, the sweet spot of lenders like JPMorgan. All told, W&D’s goal is to hit $13 to $15 a share in earnings by 2025, up from an estimated $8.67 this year.
The firm, and its stock, do face threats. Rising interest rates depress acquisition activity and asset values as capital costs rise. Refinancings could slow. Lenders have some protection, since commercial loans typically have prepayment penalties that make it onerous to refinance. Nonetheless, Walker says, “we’re in no man’s land” with rates.
W&D also needs Fannie and Freddie to stay market-friendly. The mortgage agencies imposed caps on multifamily funding in 2013 and plan to limit lending to $140 billion combined this year. Any hints of a pullback, along with stiffer lending requirements, would probably affect the stock. “It’s a risk to Walker if Fannie and Freddie shrink,” says Wolfe Research analyst Matt Howlett, who nonetheless likes the stock.
CEO Walker says he isn’t concerned about Fannie and Freddie, noting that they are supplying ample capital to the market. And the firm has other funding sources. “Deals that aren’t going to get done by the agencies, we’ll get done with insurers, banks, our own balance sheet, or securitized debt,” he says.
With a digestible size for a big bank or financial firm, W&D could become an acquisition target. Walker says that if a buyer offered $150 a share, he would be obligated to entertain it. Still, he has no intention of selling or stepping down. “Working for your own equity is better than working for someone else’s,” he says. “I’m 53 and don’t plan on going anywhere.”
Write to Daren Fonda at [email protected]
