Starwood Property Trust (STWD), a mortgage REIT (Real Estate Investment Trust), was a recent Spotlight Stock in my newsletter, Wall Street’s Best Digest.
The company was recommended by Tim Plaehn, of The Dividend Hunter, due to its stable dividends, even during stock market corrections.
REITs have long held a special place in my various stock portfolios. Back in the tech boom and bust of the late 1990s, the cash flow from my REIT holdings kept my portfolio in the black when many others were crashing and burning.
REITs were created in 1960 by an act of Congress to allow individual investors to participate in the ownership (and profits) of large-scale, income-producing real estate properties. Like mutual funds, they allow individual investors to “pool” their monies to invest, while sharing the risk of the investments. They are also excellent tools when used to diversify your portfolio as well as to allocate your assets. And, as with mutual funds, they are professionally managed.
But REITs have one tremendous selling point not shared by most mutual funds: high dividend yields.
By law, REITs must return at least 90% of their taxable income to their shareholders, annually, which generally translates into very nice yields for the REIT investor, making these investment vehicles very attractive.
Mortgage REITs lend money directly to owners and operators of real estate, or acquire loans or mortgage-backed securities. Many of them also manage their interest rate and credit risks using derivative strategies such as securitized mortgage investments and dynamic hedging techniques. Their best-known investments are Fannie Mae and Freddie Mac, government-sponsored enterprises that buy mortgages on the secondary market.
Starwood Property Trust Stock: A Mortgage REIT for a Low-Interest-Rate World
During this time of very low interest rates, mortgage REITs are very attractive. Here is a brief summary of the positive characteristics of Starwood, from Tim Plaehn:
“The finance REIT’s primary business is the origination of commercial property mortgages. As one of the largest players in the field, Starwood focuses on making large loans with specialized terms.
“The scale gives the company a competitive advantage over banks and smaller commercial finance REITs.
“In recent years, Starwood has acquired what is now the largest commercial mortgage servicing firm in the nation. That arm of the business handles servicing, foreclosure workouts (for fees), and the packaging of smaller commercial mortgages into mortgage-backed securities. Over the last few years, Starwood has acquired selected real properties, including apartments, regular office buildings, and medical office campuses.
“Starwood also has invested in residential mortgage and infrastructure lending. Real Estate Investing and Servicing (REIS) includes CMBS Investing, Special Servicing, and CMBS Loan Origination.
“For the first three quarters of 2020, Starwood reported core earnings per share of $0.55, $0.43, and $0.50, respectively. The second quarter included the height of the pandemic crisis. During that time, Starwood reduced new investments and built up $800 million cash on the balance sheet. The core earnings still provided 90% coverage of the dividend, and the dividend was again fully covered in the third quarter. Starwood has paid a $0.48 per share quarterly dividend since the 2014 first quarter, working out to 28 consecutive dividends paid to STWD investors.
“I view the Starwood dividend as one of the most secure in the high-yield stock space. Starwood Capital, a real estate-focused private equity company with over $60 billion of assets under management, manages the REIT. Starwood Capital is a 2,200 person global organization, and Starwood Property Trust taps into that reach and expertise to find high value commercial mortgage prospects and other investments.
Why Commercial Mortgage REITs
Starwood is the largest commercial mortgage REIT, holding a $17 billion diversified portfolio of first mortgages and mezzanine loans, ranging from $50 million to $500 million. It is headquartered in Greenwich, Connecticut, has offices in New York, London, and San Francisco, and operates in both the U.S. and Europe.
Commercial mortgage REITs tend to be less sensitive to government policy and involvement than residential mortgage REITs since their loans are sourced, originated, and maintained by private companies rather than government agencies.
Commercial vacancy rates increased in 2020 (due mostly to the pandemic and the remote working trend). But NAREIT says that trend should reverse for two reasons:
- There is not a large new supply of buildings being completed.
- The long-term leases for most types of commercial real estate help buffer the impact of a crisis that came on very quickly but whose rebound also began with little delay.
Starwood has managed to be profitable even during the coronavirus pandemic, increasing its third-quarter earnings 8% sequentially and 6% year-over-year. The majority of the company’s loan portfolio consists of first mortgages, averaging a loan-to-value ratio of 60-65%, which gives the REIT a nice cushion during uncertain economic periods.
Starwood has competitive advantages due to its varied investment strategies, its size, and strong balance sheet. And during the trying times of 2020, the REIT did not restructure its debt by taking on costly capital and it did not cut its dividend, like some of its peers.
With a 7.8% dividend yield, what’s not to like about Starwood Property Trust stock?